THE ISSUE OF ENDOGENEITY

The literature on endogenous money supply in India described how the issue of endogeneity of money supply was born when RBI relied on credit control on banks in 1970s, but found it ineffec­tive because banks managed to take advantage of loopholes in the definition of deposits or credit, use cash credit, and mobilize non-deposit resources.

In the above literature (a) endogeneity of money supply is attributed to the lending activities of the banks and (b) the theoretical propositions by and large belong to the post Keynesian school.

Without credit finance it is not feasible to obtain positive netput (net output) in the economy given the feedback from price to output via money. This result is in line with Dash and Goyal (2001). They found that during the credit liberalization regime the banks were circumventing the RBI control and expanding credit. Again Rangarajan and Arif (1990) found price level to have been determined by money supply also. Again during post liber­alization regime banks got more autonomy in extending credit. It seemed that bank credit had influenced prices, which in turn had influenced output. Thus GDP responded strongly to price.

In the relationship between nominal GDP and broad money the residuals are purely stochastic,

i. e. white noise. The economics of the above result lies in the fact that true nominal GDP growth is backed by real GDP growth. Increase in volume of goods and services need be accompanied by increase in the volume of money supply in order to lubricate the exchange processes and facilitate transactions. Again it is also true that endogenous money supply in the form of bank credit increases in the wake of increase in planned output.

Another explanation can be in the context of exchange rate of rupee vis-a-vis other currencies. When domestic output increases transaction de­mand for money increases and hence total demand for money increase. This makes rupee appreciate ceteris paribus vis-a-vis other currencies like US dollar or the reference basket of currencies. Too much of such appreciation may create undesir­able quantum of foreign exchange outflow. So the Central Bank might require to increase money supply to the extent sufficient to make the value of rupee reduce to the target level or it has to buy US dollars sufficient in exchange for rupee to make US dollar appreciate vis-a-vis rupee or do both in order to maintain a the desired level of rupee/ US dollar rate.

From the above relationships involving com­mercial bank credit, industrial output index and wholesale price index Das (2010) found that in­dividually commercial bank credit and wholesale price index have strong influences on industrial output. Butjointly they do not influence industrial output perhaps because wholesale price index is correlated to commercial bank credit. Thus one can say that because their correlation coefficient between is as high as 0.976, commercial bank credit raises the real cost of production which has an adverse effect on industrial output. This goes against Rangarajan and Mohanty (1997).

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