The Counterintuitive Nature of Money Creation by Commercial Banks

The Problem of Constraints on Bank Money Creation

Causality of Money Creation: Loans Create Deposits

Example of Money Creation: The Alpha Bank Loan

Self-Financing Nature of Bank Loan Creation

Figure 6.12a: Visualizing Money Creation Through Lending

Economic Impact of New Debt from Money Creation

A commercial bank approves a $50,000 loan for a small business to purchase new equipment. At the moment the loan is issued and the funds are credited to the business's account, what is the immediate impact on the total supply of deposit money in the economy?

A business owner is applying for a loan at a commercial bank. Two bank advisors offer different explanations for how the bank can fund the loan:

• Advisor A: "We will check our reserves to see if we have enough money from other customers' savings deposits. If we do, we can lend a portion of those existing funds to you."
• Advisor B: "The act of approving your loan will itself create a new deposit in your account. We don't need to use someone else's money; we create the funds for your loan at the moment it is issued."

Which advisor provides the most accurate description of how the loaning process creates new money in the economy?

Balance Sheet Impact of Loan Creation

For a commercial bank to issue a new loan to a customer, it must first attract an equivalent amount of deposits from its savers to ensure it has the funds available to lend.