How banks create money - The fundamentals of economic theory

How banks create money

Another circumstance that governments take into account in macroeconomic regulation of the economy is the ability of banks to "create" money, increasing the money supply. The fact is that in countries with a developed banking system, there is a rapid growth in the amount of deposit-credit of the money supply (i.e., those that appear as deposits into banks and, therefore, can be provided in credit). So: banks create ; money when they accept deposits and, having deducted the required reserve from their amount, use the remaining deposit mass to issue loans. As a result of repeated repetition of such operations along the chain of banks in the economy, so-called credit expansion occurs and "new" (extra money. This multiplier mechanism for increasing the money supply can be traced in the following simplified example (Figure 7.14).

Let's assume that 100 CU is contributed to our 1st bank. and that at the same time the norm of reserve capital established by the central bank is 20%. Then, after complying with the mandatory reserve requirements of CU20. (20% of CU100), the bank will give a loan of CU80. (100-20). Received by someone, this loan through payment of various accounts will eventually turn into a deposit, say, in the 2nd bank. The latter, having contributed 16 CU to the reserve. (20% of CU80), will provide 64 CU on credit. (80 - 16). This amount, similarly having passed all your settlement-payment way, will appear as a contribution already in the 3rd bank. And so on, until melting when moving from bank to bank, the original amount will not dissolve without a balance in bank accounts.

As a result of a similar "chain reaction" the initial money will increase many times. Even in our short example, brought only to the third bank, the sum of new money will be no less than 144 CU. (80 + 64). The maximum growth rate of the money supply, or, as it is also called, the money multiplier, is the inverse reserve capital.

So, in our example, it is equal to 5 (since the required reserve rate is 20%, or in fractions - 1/5). That is, 80 CU. credit money launched by the 1st bank, in the end could "create" CU400 (80 x 5) new money, thereby increasing the total money supply to CU500. (100 + 400). Such a banking effect of monetary credit is taken into account by the state in its monetary (monetary) policy, because it can cause inflation when the economy is working at the limit (full employment of all resources). In pursuit of maximum profits, banks may not pay attention to "overheating" economic conditions and issue redundant loans. As a result, the growing demand for goods and services exceeds the limit of their supply, and prices rise.

With the possible measures of the state against such a development of events is linked, in particular, a special policy of the so-called "cheap" and expensive money.

How can banks increase the money supply

Fig. 7.14. How banks increase the money supply

thematic pictures

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