DP11368 | On the Money Creation Approach to Banking

Publication Date

06/30/2016

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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.