The banking system plays a key role in the money creation process from "summary" of The Economics of Money, Banking and Financial Markets, eBook, Global Edition by Frederic S. Mishkin
The banking system is a crucial player in the money creation process. When banks make loans to their customers, they are essentially creating money. This is because when a bank grants a loan, it is simultaneously creating a deposit in the borrower's account. In other words, the act of lending creates new money in the economy. This process is known as the money multiplier effect, where a single dollar of reserves can lead to multiple dollars of deposits and loans. For example, if a bank receives a deposit of $100 and has a reserve requirement of 10%, it can then lend out $90 of that deposit. This $90 is then deposited into another bank, which can in turn lend out $81, and so on. This creates a chain reaction of lending and deposit creation, resulting in a much larger increase in the money supply than the initial deposit. The ability of banks to create money through lending is a powerful tool for stimulating economic activity. By providing individuals and businesses with access to credit, banks can help fuel investment, consumption, and overall economic growth. However, this power comes with risks, as excessive lending can lead to inflation and financial instability. Central banks play a crucial role in overseeing this money creation process. They set reserve requirements for banks, conduct open market operations to control the money supply, and act as lenders of last resort to prevent financial crises. By regulating the banking system and managing the money supply, central banks can help ensure stability and efficiency in the economy.- The banking system's ability to create money through lending is a fundamental aspect of modern economies. By understanding this process and the role of central banks in overseeing it, we can better grasp the dynamics of monetary policy and its impact on the economy.
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