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Bank credit and money creation in a DSGE model of a small open economy

Author

Listed:
  • Jaunius Karmelavicius

    (Financial Stability Department, Bank of Lithuania and Faculty of Economics and Business Administration, Vilnius University, Vilnius, Lithuania)

  • Tomas Ramanauskas

    (Financial Stability Department, Bank of Lithuania, Vilnius, Lithuania)

Abstract

By the act of lending banks do not actually intermediate pre- accumulated real resources but rather create new financial resources in the form of deposits. Therefore, bank credit needs to be modelled as a monetary phenomenon, which directly fuels domestic demand and inflationary pressures. So far, there have been just a few attempts to model banks as monetary institutions in the DSGE model. In this paper we propose a simple DSGE model, which nevertheless accommodates banks as genuinely monetary institutions and captures banks' institutional ability to create money. Our model features a small open economy with nominal prices, savers and borrowers and a banking sector. Following an exogenously induced shock to banker's willingness to lend, the bank does not have to raise deposit rates or significantly increase borrowing from abroad as deposit dynamics closely resembles that of credit, which allows us to analyse real and nominal consequences of bank credit (and money) creation.

Suggested Citation

  • Jaunius Karmelavicius & Tomas Ramanauskas, 2019. "Bank credit and money creation in a DSGE model of a small open economy," Baltic Journal of Economics, Baltic International Centre for Economic Policy Studies, vol. 19(2), pages 296-333.
    • Handle: RePEc:bic:journl:v:19:y:2019:i:2:p:296-333
    DOI: 10.1080/1406099X.2019.1640958
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    More about this item

    Keywords

    Banks; financial intermediation; money creation; credit supply; deposits;
    All these keywords.

    JEL classification:

    • E30 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - General (includes Measurement and Data)
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E51 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Money Supply; Credit; Money Multipliers
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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