The Controversial Treatment of Money and Banks in Macroeconomics

Abstract

This paper offers a basic overview of the practical aspects of money creation. A brief presentation of the history of money and a critical summary of the commonly accepted theories highlight the current understanding of the emergence and operating characteristics of money in the modern economy. We follow the distinction between inside and outside money creation. Inside money is jointly determined by the private sector’s need for money, together with the banking system’s money creation potential. This paper focuses on inside money along the lines of the endogenous money theory. We demonstrate the main features of money flows and the money created by banks. Outside money is created by the state (not the private sector), and its creation can only be indirectly influenced by the money demand of the private sector. A brief overview of the historical process of the emergence of money provides a framework to assess and compare the main elements of the chartalist and metallist concepts of money. Concerning the current debates about the role of the banks in money creation, we compare three theories focusing on money creation. These three theories treat the role of banks in money creation differently. The endogenous money theory based on a convincing description of money flows offers a reliable interpretation of the current monetary policy. One striking conclusion of the endogenous money theory is that banks do not need savings in advance to lend, as lending in itself is considered money creation.

Keywords: Endogenous Money Theory, Money Creation, Fiat Money, Money Multiplier, Outside Money, Inside Money

JEL Classification: E40, E50, E51, E59