The Adjustment Process of the Money Multiplier and the Loanable Funds Model

This section shows how the retail banks can create (or destroy) loans and liabilities in the form of money credit, depending on lending opportunities, interest rates and the prevailing winds of uncertainty and perceived credit risk. This inside money supplied by commercial banks is the main ingredient of the supply, whereas the outside money supplied by the Central Bank is the minor one. Retail banks create inside money by creating deposits when they make a loan. The loan is later destroyed when the customer completes its repayment. Banks use available reserves in the form of internal profits from interest payments, the selling of financial assets and securities, buying reserves from other banks as well as reserves held at the Central Bank or borrowing from it in order to generate profit in the form of interest payments from the geometric process of credit growth and this represents a cumulative (or diminishing) process based on monetary circuitism. Demand is then matched with the supply, so that the rate of interest on borrowing can be determined.