Proceedings of the 33rd International Academic Conference, Vienna

BANKS CANNOT EITHER MULTIPLY OR INCREASE THE AMOUNT OF MONEY OR CREATE DEPOSITS WITHOUT BACKING OF MATCHING RESERVE; ONLY CENTRAL BANK CREATES MONEY

NABA KUMAR ADAK

Abstract:

This paper presents a critical analysis of whether banks can multiply their available existing deposits of money, that is their liability, and or whether banks can create new money and thereby increase money supply. Economists held different views. Some argue that individual bank cannot multiply credit. Some view individual bank can multiply credit if the borrowers purchase with the borrowed money and, then, the sellers deposit successively the same money in the same bank, the money can be multiplied to the extent of credit divided by reserve ratio times. Some others argue that banks don’t need deposit at all; it can create money when it gives loan and deposit it in the borrower’s account. They are of the view that “The money supply is created as ‘fairy dust’ produced by the banks individually, “out of thin air”. (Werner 2014, P1). From the critical review of these theories, some important issues come to the surface. First, Money cannot be multiplied, second, money cannot be created out of thin air, third, what is increased is only the IOUs from the banks to their customers and from the customers to their banks, fourth, as banks are bound to keep certain percent of their reserve (deposit) in the custody of the central bank, in every successive deposit the quantity of money reduces and after the final deposit and lending all money will be placed at the custody of the central bank. No money will be there in the economy to repay the loan and its interest. Repeated depositing and lending of same money, thus, reduces the money available for economic activities.

Keywords: Credit creation, money multiplier, financial intermediary, reserve ratio, central bank reserve, deposit, IOU, creation and destruction of money

DOI: 10.20472/IAC.2017.33.001

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