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The determination of the money supply: flexibility versus control

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  • Goodhart, C. A. E.

Abstract

During the last two centuries there have been four main approaches to analysing the determination of the money supply, to wit: (1) Deposits cause Loans, (2) The Monetary Base Multiplier, (3) The Credit Counterparts Approach and (4) Loans cause Deposits. All four approaches are criticized, especially (2) which used to be the standard academic model, and (4) which is now taking over as the consensus approach. Instead, I argue that banking is a service industry, which sets the terms and conditions whereby the private sector can create additional money for itself. The problem is that such money creation tends to be highly procyclical, so the question then becomes finding the best trade-off between official control of that process and allowing sufficient flexibility for the private sector. I conclude by reviewing how Lord King's reform proposals, in his book on The End of Alchemy, might fit into this broader analysis.

Suggested Citation

  • Goodhart, C. A. E., 2017. "The determination of the money supply: flexibility versus control," LSE Research Online Documents on Economics 84209, London School of Economics and Political Science, LSE Library.
  • Handle: RePEc:ehl:lserod:84209
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    References listed on IDEAS

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    1. Werner, Richard A., 2014. "How do banks create money, and why can other firms not do the same? An explanation for the coexistence of lending and deposit-taking," International Review of Financial Analysis, Elsevier, vol. 36(C), pages 71-77.
    2. Charles A. E. Goodhart & Meinhard A. Jensen, 2015. "A Commentary on Patrizio Lainà's 'Proposals for Full-Reserve Banking: A Historical Survey from David Ricardo to Martin Wolf'," Economic Thought, World Economics Association, vol. 4(2), pages 1-20, September.
    3. Werner, Richard A., 2014. "Can banks individually create money out of nothing? — The theories and the empirical evidence," International Review of Financial Analysis, Elsevier, vol. 36(C), pages 1-19.
    4. Jakab, Zoltan & Kumhof, Michael, 2015. "Banks are not intermediaries of loanable funds – and why this matters," Bank of England working papers 529, Bank of England.
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    Cited by:

    1. Decker, Frank & Goodhart, Charles A, 2018. "Credit mechanics - a precursor to the current money supply debate," CEPR Discussion Papers 13233, C.E.P.R. Discussion Papers.
    2. Hiermeyer, Martin, 2018. "A Tautologies-Founded IS-LM Model," MPRA Paper 83681, University Library of Munich, Germany.

    More about this item

    JEL classification:

    • F3 - International Economics - - International Finance
    • G3 - Financial Economics - - Corporate Finance and Governance

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