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On the money creation approach to banking

Author

Listed:
  • Salomon Faure

    (ETH Zurich)

  • Hans Gersbach

    (ETH Zurich and CEPR)

Abstract

We study today’s two-tier money creation and destruction system: Commercial banks create bank deposits (privately created money) through loans to firms or asset purchases from the private sector. Bank deposits are destroyed when households buy bank equity or when firms repay loans. Central banks create electronic central bank money (publicly created money or reserves) through loans to commercial banks. In a simple general equilibrium setting, we show that symmetric equilibria yield the first-best level of money creation and lending when prices are flexible, regardless of monetary policy and capital regulation. When prices are rigid, we identify the circumstances in which money creation is excessive or breaks down and the ones in which an adequate combination of monetary policy and capital regulation can restore efficiency. Finally, we provide a series of extensions and generalizations of the results.

Suggested Citation

  • Salomon Faure & Hans Gersbach, 2021. "On the money creation approach to banking," Annals of Finance, Springer, vol. 17(3), pages 265-318, September.
    • Handle: RePEc:kap:annfin:v:17:y:2021:i:3:d:10.1007_s10436-021-00385-5
    DOI: 10.1007/s10436-021-00385-5
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    Cited by:

    1. Gersbach, Hans & Zelzner, Sebastian, 2022. "Why Bank Money Creation?," CEPR Discussion Papers 17753, C.E.P.R. Discussion Papers.
    2. Salomon Faure & Hans Gersbach, 2022. "Loanable funds versus money creation in banking: a benchmark result," Journal of Economics, Springer, vol. 135(2), pages 107-149, March.
    3. Althanns, Markus & Gersbach, Hans, 2023. "The Monetary Policy Haircut Rule," VfS Annual Conference 2023 (Regensburg): Growth and the "sociale Frage" 277597, Verein für Socialpolitik / German Economic Association.

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    More about this item

    Keywords

    Money creation; Bank deposits; Capital regulation; Zero lower bound; Monetary policy; Price rigidities;
    All these keywords.

    JEL classification:

    • D50 - Microeconomics - - General Equilibrium and Disequilibrium - - - General
    • E4 - Macroeconomics and Monetary Economics - - Money and Interest Rates
    • E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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