Money Creation: Misconceptions: It Begins with a New Deposit

Abstract

Founded on the money multiplier, the imminent demise of which is not overstated, there exists a profound misconception: that money creation begins with a new deposit. In many cases the source of the new deposit is not specified, and somehow the recipient bank acquires reserves. In other cases the source is specified: cash (ie bank notes and/or coins), which does provide reserves, but the subsequent process is mistreated. The worst offense is to base one of the most significant issues in economics on a supply of bank notes and coins (which is limited because it is a non-interest-bearing asset, and which makes up 2-5% of M3). The analyses presented are partly correct: that new bank loans concurrently create new deposits (money), but the starting point is disingenuous. They also obscure the significant reserves-accommodating role of the central bank as well as the role of its policy interest rate in monetary policy, the essence of which is influencing the demand for bank loans through bank lending rates.

Keywords: money, money creation, money creation misconceptions, central banking, banking, monetary policy

JEL Classification: A22, E42, E51, E52, G21