January 15, 2020

Charles M. Kahn, University of Illinois

The issue is whether the “money creation” view of banking or the “financial intermediation” view of banking is the correct one. I’ll use Andolfatto’s summary of the views: “The heterodox view [i.e. the money creation view] is that banks are critically different from other financial market participants. In particular, while non-bank agencies wanting to finance investments first need to acquire the requisite funding, this is not the case for banks. In contrast to the non-bank sector, banks can create the money they lend.” The financial intermediation view (he calls it the orthodox or mainstream view) is that for the purposes of business cycle analysis, “it makes little sense to draw a sharp distinction between which … liabilities constitute ‘money’ and which do not … The fact that bank lending creates money—i.e., that bank liabilities are more liquid than those of other financial agencies—is not a critical consideration.” (Andolfatto, 2018, pp. 1-2)
More “Banking: Intermediation or Money Creation
C. Kahn, Are Banks Special? A Fintech Perspective”