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The Counterintuitive Nature of Money Creation by Commercial Banks
The concept that commercial banks create new money 'out of thin air' when they issue loans can be perplexing. This idea is counterintuitive because it contradicts the common understanding of banks as mere intermediaries that lend out pre-existing funds deposited by savers.
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Introduction to Macroeconomics Course
Ch.6 The financial sector: Debt, money, and financial markets - The Economy 2.0 Macroeconomics @ CORE Econ
The Economy 2.0 Macroeconomics @ CORE Econ
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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.
Learn After
A commercial bank has total customer deposits of $10 million. The bank approves a new $500,000 loan for a local construction company. When the loan is issued, the bank credits the company's checking account with the full amount. Immediately after this single transaction, what is the new total of customer deposits held at this bank?
The Role of Banks in Money Supply
Analyzing a Common View of Banking
A commercial bank functions primarily as an intermediary, collecting funds from savers and then lending those same funds to borrowers. Consequently, the total amount of new loans a bank can make is strictly limited by the total amount of its existing customer deposits.
Bank Balance Sheet Analysis
Critique of the Bank Intermediary Model
There are two competing views on how commercial banking functions. Match each statement below to the conceptual model it best represents.
Analyzing a Public Statement on Banking
A politician makes the following statement: "To stimulate economic growth, we must encourage households to save more. This increased pool of savings will allow our commercial banks to lend more money to businesses for investment." Which of the following provides the most accurate critique of the politician's statement based on the actual mechanics of the modern banking system?
A commercial bank approves and issues a $100,000 loan to a customer. Arrange the following outcomes of this single transaction in the correct logical sequence to illustrate how new money is created.