Banking: Intermediation or Money Creation
Roundtable 1 Prompt

Contributors: Morgan Ricks, Marc Lavoie, Robert Hockett, Saule Omarova, Michael Kumhof, Zoltan Jakab, Paul Tucker, Charles Kahn, Daniel Tarullo, Stephen Marglin, Howell Jackson and Christine Desan

Prompt for Discussion

Commercial banks are, indisputably, at the center of credit allocation in virtually all modern economies. Astonishingly, however, it remains controversial exactly how banks expand the money supply.

According to one view, banks operate as intermediaries who move money from savers to borrowers. The basic idea is that banks extend the monetary base by lending out of accumulated funds in a reiterative way. In round 1: a bank takes a deposit, sets aside a reserve, lends on the money; round 2 – the money lands in another bank, that bank sets aside a reserve, lends on the money; round 3 – the process repeats. Money’s operation is effectively multiplied in the economy because banks transmit funds constantly from (passive) savers to (active) borrowers, thus distributing money across those hands. The system works because savers, who are content to leave their funds alone, are unlikely to demand more than the (respective) reserve amounts back from any round. Banks balance their flow of funds over time as borrowers repay their loans.

Banking: Intermediation or Money Creation
M. Lavoie, Endorsing the Money-creation View

January 08, 2020

Marc Lavoie, University of Ottawa

We are being asked whether we support the traditional intermediation view of banking or the money-creation view. The second scholarly article that I ever published, 37 years ago, was a presentation of the arguments providing support to the so-called endogenous theory of money, as post-Keynesian economists like to call it, or what Richard Werner calls the credit-creation theory of banking. Thus, in response to the question put to us, influenced by my readings of some French monetary specialists, in particular Jacques Le Bourva, I would answer that I have long rejected the traditional intermediation view and endorsed instead the money-creation view. This view of banking denies that banks are constrained by prior deposits or by the amount of reserves in the system, since the causal arrow goes from loans to deposits to reserves. When making new loans, loan officers don’t phone up other departments to find out whether there are enough deposits in the bank or whether there are excess reserves. Relative to the traditional intermediation view, there is reversed causation. There is no money multiplier; at best one could speak of a credit divisor.