Where does money come from? Out of nothing.

by David Gerlitz on February 22, 2012

According to mainstream economics, customer deposits allow banks to on-lend those deposits and make loans. Banks then hold a portion of those deposits in “reserve” for customer withdrawals. You may have heard of this referred to as the “money multiplier.”

The reality is, of course, exactly the opposite: banks don’t need deposits to make loans because the loan itself creates the deposit.(1)

Banks make their loan determinations based on the credit-worthiness of the customer, their capital requirements (2) and the cost of obtaining any reserves it would need ( if any) after creating the loan.

This is called endogenous money, because the money supply is determined by the preferences of actors in the real economy. For example, your need to spend on credit expands the money supply and didn’t come from anyone else’s pre-existing deposit. So the appropriate causation says: Loans Create Deposits. Banks create loans ex nihilo (out of nothing).

(1)  Marc Lavoie, Credit And Money: Overdraft Economies, And Post-Keynesian Economics, pp 67-69, Money And Macro Policy, ed. Marc Jarsulic, 1985.

(2) SEC rule changes in 2004 make even capital requirements a suspect drag on bank lending, particularly for investment banks.

 

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