On the Money Creation Approach to Banking

67 Pages Posted: 7 Jul 2016 Last revised: 16 Aug 2020

See all articles by Salomon Faure

Salomon Faure

ETH Zürich

Hans Gersbach

ETH Zurich - CER-ETH -Center of Economic Research; IZA Institute of Labor Economics; CESifo (Center for Economic Studies and Ifo Institute); Centre for Economic Policy Research (CEPR)

Date Written: June 2016

Abstract

We study today's two-tier money creation and destruction by commercial banks via deposit/loan creation to firms and by central banks via deposit/loan creation 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.

Keywords: Money creation - Bank deposits - Capital regulation - Zero lower bound - Monetary policy - Price rigidities

JEL Classification: D50, E4, E5, G21

Suggested Citation

Faure, Salomon and Gersbach, Hans, On the Money Creation Approach to Banking (June 2016). CEPR Discussion Paper No. DP11368, Available at SSRN: https://ssrn.com/abstract=2804546

Salomon Faure (Contact Author)

ETH Zürich ( email )

Zurichbergstrasse 18
ZUE D11
Zürich, 8092
Switzerland

Hans Gersbach

ETH Zurich - CER-ETH -Center of Economic Research ( email )

Zürichbergstrasse 18
Zurich, 8092
Switzerland
+41 44 632 82 80 (Phone)
+41 44 632 18 30 (Fax)

IZA Institute of Labor Economics

P.O. Box 7240
Bonn, D-53072
Germany

CESifo (Center for Economic Studies and Ifo Institute)

Poschinger Str. 5
Munich, DE-81679
Germany

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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