Banking: Intermediation or Money Creation
S. Das, Roundtable Wrap-up

August 3, 2020

Sannoy Das, Harvard Law School

In this brief post, I attempt to summarize the main themes that emerged from the Just Money roundtable on banking. In ten blog posts between January and March 2020, before the coronavirus pandemic turned the world upside down, our contributors set out to answer the question of what it is that banks do; and more importantly, why understanding what they do is so important. The prompt for the roundtable asked our contributors to discuss the two known paradigms about how banks work: on the one hand, the view that banks intermediate funds between savers and borrowers (often the ‘orthodox’ view), and, on the other, that banks create money through lending (the ‘heterodox’ view). Most of our contributions also address, some more directly than others, what is at stake in choosing between these views about banking. Our contributors, as we will see, disagree on how and whether the choice of paradigm dictates normative choices about the regulation of financial market entities, and, perhaps more fundamentally, whether the debate over views about banking is enmeshed in a broader ideological struggle about the relationship between public power and economic activity.

Marc Lavoie, in the first contribution to the Roundtable, answers the prompt most directly, offering a clear statement of the heterodox ‘money-creation’ view and its venerable historical antecedents. For Lavoie, this view puts the difference between the banking system and the ‘shadow-banking’ system in sharp relief – and thus offers a path ahead for regulators in handling crises in financial markets. Howell Jackson on the other hand, argues that policy makers ought not to abandon the orthodox intermediation theory, because crises such as bank runs are, in his view, events of dis-intermediation. For Jackson, the intermediation theory persuasively describes the behavior of practical bankers, always interested as they are, in acquiring their deposits. And this, in my view, opens up an interesting question:  in picking between these two theories, should we look for one that best approximates the experience of bankers or one that best captures some fundamental dynamic about the banking system? The case that Jackson and Charles Kahn make is that intermediation view describes the constraint that bankers face in lending. Others, as we will see below, believe that this constraint is a tangential consideration in picking the better theory.

Sir Paul Tucker, formerly of the Bank of England, argues that there is nothing heterodox about the view that bank deposits, which are money, are created by banks in their act of lending. But for reasons of mathematical simplicity, the idea that banks intermediate funds according to rules of fractional reserve banking and the related idea of the ‘money multiplier’ are embedded in economics textbooks. These concepts may have made better sense in a context where central banks regulated a bank’s ability to create money by controlling the supply of reserves, not in the (more current) context where the primary policy tool for central banks is regulating interest rates. Tucker’s bigger takeaway, however, is that debating theories of banking is to put the cart before the horse. What matters more is to craft policy measures that keep the monetary system stable, given our agreement that banks affect the money supply and are volatile institutions. In a stable monetary system, where bank deposits are safe assets, banks will be able to drive money supply by extending credit.

But others take the flip side of Tucker’s cart-and-horse. They argue that the view that we adopt about the nature of bank activity shapes our approaches to bank regulation. For Morgan Ricks, the distinction between the two views of bank operations influences the question of how to regulate financial entities at a normative level. In his view, the ‘intermediation’ approach primarily serves to blur the distinction between banks and other financial institutions in service of two conservative policy outcomes. First, the intermediation paradigm suggests a deregulatory bias for banking, since it appears similar to other financial entities and second, the paradigm invites other financial market participants, such as hedge funds, to stake claims for support from the central bank. Stephen Marglin echoes Ricks by noting the mediation orthodoxy is ultimately an “ideological tool in the fight for deregulation.” This is why it remains in textbooks, despite the flawed underlying assumption that banks play a passive role in the economy. For Marglin, the difference between the two views on banking does not turn on the question of how constrained bankers are in making loans (indeed, he admits that reserves can be constraining). Instead, it turns on understanding whether reserves or the money multiplier are exogenous to banking activities – a premise he rejects. Reserves and the money supply are determined by the actions of bankers, which explains the frequent situation of excess reserves in the banking system.

One broad takeaway from Marglin’s contribution is that how we pick between the two ideal-type accounts depends on some broader conceptions of the field of macroeconomics. This much is evident in the disagreement between Charles Kahn on the one hand and Kumhof and Jakab on the other. Kahn’s argument is that while it is true that banks create ‘money’, this is predicated on defining money to include bank deposits and to exclude many other forms of credit. Conceptually, for Kahn, the important consideration is not whether an asset (debt) is money, but whether it is liquid – for if it is liquid, it can function like money. If the more relevant macroeconomic variable is liquidity, then banks are similar to many institutions that issue, or are capable of issuing, liquid debt. Without the backing of deposit insurance, or implied too-big-to-fail protections, banks would be constrained in issuing debt, just like other financial institutions. Thus, Kahn argues that without reference to the macroeconomic context in which particular banks operate, it would be misleading to state that bankers can simply issue debt with the ‘stroke of a pen.’ To Kahn, given that there is nothing fundamentally exceptional about banks, the intermediation paradigm is a good fit.

Michael Kumhof and Zoltan Jakab disagree pointedly. For them, focusing on liquidity as the appropriate marker for differentiating (or obliterating the difference) between banks and other financial institutions is a mis-step, one that will undermine our understanding of crisis and regulation. Instead, the fact that a banker can create debt ex nihilo and a non-banking financial institution cannot (all conditions being equal), is critical. It explains why bank balance sheets are more fragile and why the increase or contraction of money flow is much faster in response to slight perceived changes in macroeconomic conditions. Their point, of course, is not to deny that bankers are constrained in how they make out loans, but that the constraint is ultimately based on the banker’s view of profitability, which is theoretically (yet significantly) distinct from the need to first have attracted deposits.

I noted above that Morgan Ricks approached the debate between the two views of bank operations as a proxy for the fight for deregulation. For Daniel Tarullo, this overestimates the significance of differentiating between the two views. Deregulation created a financial system with a shrinking role for traditional deposit-creating (or deposit-taking) banks and increased prominence of ‘shadow banking’ institutions, paving a path to the 2008 crisis. Given that the financial crisis arose out of risks that had little to do with traditional banking, for Tarullo, the importance of picking the right view of how traditional banks work is exaggerated. Instead, for Tarullo, managing risks in the financial system requires a stronger regulatory framework for non-banking financial entities, even if that does not exactly mimic traditional banking regulation.

We might differ with Tarullo however, if we believe that views about banking are embedded within larger frameworks about the relationship between finance and economic activity. As Christine Desan argues, the intermediation view about banks bears an emphatic connection with the idea that economic activity is the outcome of individual initiative: saving and borrowing. Taken as truth, this casts a shadow over our understanding of the history of economic development and the role of state institutions. Thus, Desan places the debate about banking operations within a set of discourses that constitute the neoclassical veridiction for the State’s role in the economy. We are led to mistakenly believe what the drivers of economic development were, and thus to forget that it was creation of novel forms of credit, not the accumulation of existing funds, that prompted capitalist growth.

Like Desan, Hockett and Omarova take to task assumptions about the essentially ‘private’ nature of banking activity. Flipping the intermediation account on its head, they argue that banks intermediate between us (as the sovereign people) and our ‘selves’ (as private actors). In their account, when a bank creates money by issuing credit, this is a way of transforming our private credit-worthiness into a public form, backed ultimately by the ‘full faith and credit’ of the polity. It is this ‘full faith and credit’ that banks are capable of putting into circulation – making them franchisees of the ultimate asset of the sovereign state.

As I noted at the start, at the heart of this Roundtable prompt was the question of what is at stake when we investigate what is it that banks do? Here, I might simply paraphrase from Christine Desan’s contribution addressing what her colleagues understood the stakes to be – matters of disciplinary accuracy, normative questions of regulation and macroeconomic policy, the relationship of public power to private economic action, or of “expositional fit.” To this mix, she adds her own – our understanding of the process of economic development, and thus she concludes that “the stakes could not be… bigger.” I am tempted to agree with her. How we interpret the world of banking appears linked to how we understand some fundamental aspects of production and distribution in society. The distributional stakes remained somewhat hidden from view in this Roundtable, but they lurk under the surface. If banks are the “means of money creation,”[1] then the better account of banking will offer the better account of inequality. We will still have to answer whether a firmer understanding of banking fulfills the great task of philosophy – which is to change the world (for the better)!


[1] I owe this phrase to Christine Desan – it emerged during our conversations over the last two years.

Special Edition: Money in the Time of Coronavirus

Special Edition: Money in the Time of Coronavirus

Prompt for Discussion

Contributors: Katharina Pistor, James McAndrews, Saule Omarova, Mark Blyth, Jamee Moudud, Elham Saeidinezhad, Dan Awrey, Fadhel Kaboub, Leah Downey, Virginia France, Lev Menand, Nadav Orian Peer, Robert Hockett, Carolyn Sissoko, Jens van ‘t Klooster, Oscar Perry Abello, and Gerald Epstein

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The financial strains brought by the coronavirus outbreak feel strangely reminiscent of 2008, and yet, markedly different. In the United States, at the writing of this prompt, the S&P 500 has crashed 25%, and the federal funds target rate is once again moving towards the zero bound. The treasury securities market is in disarray, and the Federal Reserve is set to increase its repo lending by over one trillion. In Washington, the administration’s insistence that concerns were overblown is now replaced with negotiations over the size and shape of a stimulus package. “I don’t want to use the b-word”, said a senior administration official about plans to support distressed industries, like airlines. The b-word is, of course, bailout. 

So far, so 2008. But the monetary dynamics we are witnessing in the time of corona also take us into new territory.  The proximate cause of the crisis past came from within the financial system itself: the housing credit bubble and abuses in subprime lending. The corona crisis, on the other hand, emerges from a material threat to human health.   Where the 2008 crisis revealed the vulnerabilities of financial globalization, the corona crisis is disrupting the global production system, upending supply chains, and threatening shortages in essential inventories.  

We wonder about the extent to which the policy arsenal of 2008 can contain the dislocations currently occurring, and what, exactly, stimulating consumer demand means when the consumer herself is in quarantine.  Moreover, the crisis response to the corona crisis is taking place within an institutional setting that was itself reshaped by the 2008 crisis reforms. As corona strains unfold, it remains to be seen whether the promise of financial resilience will be borne out, or whether fundamental design flaws left in place will frustrate reformers’ efforts. 

In this Special Edition Roundtable, JM invites contributors to provide live analysis of money in the time of corona, here in the U.S., and around the world.




June 29, 2020
Roundtable Wrap-up
Sannoy Das, Harvard Law School

May 21, 2020
Human Capital Bonds and Federal Reserve Support for Public Education: The Public Education Emergency Finance Facility (PEEFF)
Gerald Epstein, University of Massachusetts 

May 12, 2020
The Fed Should Bail Out Low-Income Tenants and Not Just Banks and Landlords
Duncan Kennedy, Harvard Law School

April 29, 2020
Getting to Know a Brave New Fed
Oscar Perry Abello
, Next City

April 10, 2020
The Problem with Shareholder Bailouts isn’t Moral Hazard, but Undermining State Capacity
Carolyn Sissoko, University of the West of England

April 2, 2020
Crises, Bailouts, and the Case for a National Investment Authority
Saule Omarova
, Cornell Law School

March 31, 2020
Why the US Congress Gives Dollars to the Fed
Jens van ‘t Klooster, KU Leuven and University of Amsterdam

March 26, 2020
A Fire Sale in the US Treasury Market: What the Coronavirus Crisis Teaches us About the Fundamental Instability of our Current Financial Structure
Carolyn Sissoko, University of the West of England

March 25, 2020
The Democratic Digital Dollar: A ‘Treasury Direct’ Option
Robert Hockett, Cornell Law School

March 22, 2020
Derivative Failures
James McAndrews, TNB USA Inc. and Wharton Financial Institutions Center

March 20, 2020
The Case for Free Money (a real Libra)
Katharina Pistor, Columbia Law School

March 19, 2020
The Monetary/Fiscal Divide is Still Getting in Our Way
Leah Downey, Edmond J. Safra Center for Ethics
at Harvard University

March 18, 2020
Is Monetary System as Systemic and International as Coronavirus?
Elham Saeidinezad, UCLA Department of Economics

March 17, 2020
Here We Go Again? Not Really
Dan Awrey, Cornell Law School

March 16, 2020
Repo in the Time of Corona
Nadav Orian Peer, Colorado Law

March 16, 2020
Beyond Pathogenic Politics
Jamee K. Moudud, Sarah Lawrence College

March 15, 2020
Economic and Financial Responses to the Coronavirus
James McAndrews, TNB USA Inc. and Wharton Financial Institutions Center


Banking: Intermediation or Money Creation
S. Das, Roundtable Wrap-up

June 29, 2020

Sannoy Das, Harvard Law School

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The Just Money roundtable was convened to analyze policy responses, emerging mostly from monetary authorities, to the economic dislocations that occurred or became imminent as the coronavirus crisis hit every corner of the globe.  Most of our contributions focused on the responses by the Fed in the United States – and while this is obviously limiting in one sense, in another we gained from zooming in on the actions and authority of that agency.  The institutional role of the Fed in the American economy evolved in response to the 2008 financial crisis, and does so again here.  The deployment of the tools fashioned in that crisis offers insight into the role that monetary authorities can, and should, play in the governance of the economy.  The contributions here generally underscore the influential, even outsize, role that the Fed plays in shaping the course of the American economy.  In fact, given the position of the dollar, the Fed’s interventions will surely have significant impact on other economies too, and will condition the response of other monetary and fiscal authorities.

Sixteen contributions were published between March and May – as America moved from the earliest days of scattered local lockdowns, to deeper and more widespread orders, to down shutters.  These posts were written in the backdrop of a rapidly evolving context and speak to a wide range of questions.  In this brief summary, I am going to attempt to distil a set of fundamental concerns from otherwise very divergent contributions.  Naturally, I cannot capture all the arguments that all our authors made, and I try, post hoc, to draw connections between contributions that may be somewhat tenuous.  Nevertheless, I hope this summary offers some helpful guidance on reading the roundtable.  The entire roundtable – with a serial presentation of the contributions – is available here.

Several of our contributors ask a fundamental political question – as the Fed intervenes to protect the financial system, and the Congress passes a trillion-dollar relief package – to whom do the benefits of these interventions flow?  That distributional question sits at the heart of the Fed’s legitimacy and political identity, particularly as the COVID-19 crisis threatens to worsen escalating inequality.  Duncan Kennedy suggests that the Fed should buy up debt that is secured by mortgages over low income housing properties, conditioning this bailout on the landlord extending protection to tenants.  Similarly challenging the Fed’s focus on shoring up banks, Gerald Epstein proposes that the Fed inject liquidity into municipal governments by accepting new forms of local and state bonds – paper issued on the basis of local human capital rather than tax revenue.  Certainly, both these interventions would fall within the scope of the Fed’s powers, but they involve going beyond the role that economists conventionally assign to a central bank.  To be sure, in 2008, the Fed acted in ways that went far beyond what conventional wisdom would have admitted; donning the avatar of Oscar Perry Abello’s ‘Brave New Fed.’  This is precisely the argument now – that any constraint on the Fed acting for benefit of the American working class is ideologically constructed.  In the broader context of how politics responds to the pandemic, J.K. Moudud underscores this point about ideology, arguing that we must look beyond the ‘market fundamentalist’ obsession with shoring up stock markets and economic growth alone in response to a crisis.  By contrast, Dan Awrey mounts something of a defense for the Fed’s conventional intervention to back up banks and financial institutions by stabilizing the money market.  To be sure, Awrey’s point is not to deny the importance of monetary system reform for the benefit of American households, but merely that the Fed’s ‘subsidies’ for Wall Street are not entirely without social purpose.

Fundamental to Keynes’s challenge to nineteenth century economic wisdom was the insight that workers don’t bargain for a real wage – they bargain for the money wage.  If what matters for a stable and equitable economy is money in the hands of people, Katharina Pistor and Robert Hockett, in slightly different ways, suggest that rethinking how the dollar circulates as currency can serve that purpose.  Pistor, borrowing from the history of cooperative monies, suggests that the central bank should issue a digital currency – ‘Free Dollars’ – that depreciate over time so that recipients are incentivized to spend.  Hockett, similarly, suggests utilizing the existing digital architecture of the Treasury to create digital ‘treasury dollars’ that people can spend from their treasury direct wallets, and which would be convertible to Fed dollars.  Despite important differences between these two proposals, they have two insights in common.  First, they agree that money is ‘created’ by the banking system because that system is backed by the sovereign.  Accordingly, new ways to create money for the benefit of the people are always within sovereign prerogative.  Second, and as I noted above in respect to other posts, they reiterate that our assumptions about the Fed’s role being limited to managing the ‘financial’ system are ultimately tenuous.  Leah Downey sharpens the focus on this point by reminding us of how the abiding divide between monetary and fiscal matters serves to blunt the possibility of transformative political interventions in times of crisis.  And Saule Omarova notes that once the economy comes to be sustained on the basis of monetary and fiscal interventions, there is good reason to reconsider the possibility of a developmental role for the State by instituting a national investment authority.

Enduring questions about the vulnerability of a financial system in uncertain times appear in three contributions: one by Nadav Orian Peer and two by Carolyn Sissoko. They address matters of risk assumption by financial market participants and the regulation of that risk by the Fed.  Orian Peer addresses the rise in transactions in the ‘sponsored repo market,’ different from the tripartite repo market, where participants are better regulated by the Dodd Frank Act and Basel III norms.  The turn to sponsored repo transactions, a case of regulatory arbitrage (which Orian Peer, with literary flourish, describes as an existential feature of the human condition), threatens the stability of the financial system by undermining the regime of regulatory oversight over repo transactions that followed the 2008 crisis.  More concerning is how this ‘sponsored repo market’, now unwittingly supported by the Fed, would affect its future response as a financial crisis looms large following the pandemic.  Carolyn Sissoko points to the more general volatility of a financial system with high volumes of repo transactions.  The nature of the repo market makes it inevitable that any decline in the value of assets that are collateral for repo borrowing (the inevitable outcome of some negative sentiment in the economy) will lead to margin calls from repo lenders, triggering a ‘fire sale’ of assets, all the way down to the otherwise safe Treasury bonds.  As this played out in March, the Fed intervened to stabilize Treasury bonds, but with negative sentiment always just around the corner during a pandemic, the dark clouds of a crisis gather overhead.  In another contribution, Sissoko turns to a more fundamental question of risk and bailouts under capitalism.  State capacity under capitalism exists because the private sector is characterized as risk bearing.  Bailouts threaten that underlying compact and must for those reasons (rather than the more ubiquitous ‘moral hazard’ arguments) be considered with caution.

Two contributions by J. van’t Klooster and E. Saeidinezhad, in very different ways, offer some perspective on the global context for the Fed’s interventions. Saeidinezhad explains how the Fed’s re-establishment of central bank swap lines with five other major central banks was designed to ensure stability in the ‘Eurodollar’ market (foreign deposits denominated in US dollars), when instability became inevitable with the disruption to global trade and supply chains.  Thus, paradoxically (or not), the risk emanating from a disruption of the chained global ‘real’ economy could only be managed by the further globalization of money.  Van’t Klooster offers a brief comparative insight into the Fed’s willingness to inject liquidity against that of the European Bank.  Their point is to demonstrate that while central bankers have committed to “do whatever it takes” to keep the wheels of the financial system well-oiled, they are simultaneously concerned about managing the central bank’s exposure (more so, in Europe).  Central bankers guard against risks of ‘technical insolvency’ in order to retain their regulatory authority; committing to large scale quantitative easing requires bankers to overcome their fear of insolvency.  Unlike those who might dismiss this view of insolvency risk as pure ideology, Van’t Klooster takes this psychological condition seriously, and argues that it accordingly makes sense for the Congress to earmark a part of the relief package for the Fed itself.

Finally, while many of our contributions are invested in the thickets of monetary policy, two pieces by James McAndrews help us think more generally about managing the economy in the midst of a crisis.  How we evaluate effective economic policy depends on our basic sense of how the world (the economy) works.  Thus, McAndrews suggests that if we diagnose the economy as a set of circular flows, and the pandemic causes leakages in particular streams, then policy prescriptions designed to fix one set of flows can generate imbalances elsewhere.  Therefore, monetary policy fixes – designed to increase available credit – must be applied alongside interventions that provide income support, increase flexibility of repayment on existing debts, and enable workers to steadily rejoin the economy.  Along similar lines, in his second contribution, he reminds us that our current crisis did not arise on account of a particular problem with the money market.  Accordingly, standard tools of monetary policy will likely be insufficient, and attention must be paid to support firms through the crisis.  Policy must evaluate which firms to prioritize for support, and how best to support them.

Following leads from the contributions to the Roundtable, we’re left with many ways to think about monetary (and fiscal) interventions in a crisis.  The conventions by which we conceptualize and implement these interventions may be suspect (Downey, Omarova) and ideologically constructed (Moudud).  They include our notions of what the “economy” is (McAndrews), and influence our judgment about the distributional stakes (Kennedy, Epstein, Abello, Awrey).  Indeed, a distributional question is subtly at play in how we think about all matters of finance – how currency circulates (Pistor, Hockett), how risk and profit are engineered at the level of high finance (Orian Peer, Sissoki), and how monetary dynamics are tied together globally (van’t Klooster, Saeidinezhad).  I might close with a word of caution: our view of the present is often fragile.  In the years to come, how we evaluate this period of crisis might be well beyond our grasp at the moment.

Banking: Intermediation or Money Creation

Banking: Intermediation or Money Creation

Prompt for Discussion

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

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. 

According to another view, commercial banking activity amounts to “money creation” rather than the pooling and transmission of existing funds.  Banks fund the loans they make by issuing deposits (or promises-to-pay in the official unit of account) that are treated by the wider community as money, not only as credit.  They have, in effect, immediate purchasing power.   The constraint on banks’ lending capacity is not the sum of previously accumulated funds, but the banks’ ability to clear obligations owed to other banks against obligations demanded from other banks.  That activity depends on national payments systems coordinated and stabilized by central banks.

We open this roundtable to proponents of each approach to banking.  We invite them to argue their case, to respond to one another, and to elaborate the implications that their view has on matters including the definition of money, the role of private capital accumulation, the relationship of commercial banks to central banks, and the behavior of the money supply. 


August 3, 2020
Roundtable Wrap-up
Sannoy Das, Harvard Law School

March 12, 2020
The Power of Paradigms in Histories of Economic Development
Christine Desan, Harvard Law School

March 5, 2020
Thinking about whether and why money matters is more important than debates about “views” on banking intermediation
Sir Paul Tucker, Harvard Kennedy School

February 27, 2020
What Do Banks Do?
Stephen A. Marglin, Harvard University

February 19, 2020
Focusing on Risk
Daniel K. Tarullo, Harvard Law School

February 13, 2020
Towards a Mixed View
Howell E. Jackson, Harvard Law School

February 5, 2020
What Do Banks Intermediate?
Robert Hockett, Cornell Law School
Saule Omarova, Cornell Law School

January 29, 2020
Banks Are Not Intermediaries of Loanable Funds
Michael Kumhof, Bank of England
Zoltan Jakab, International Monetary Fund

January 23, 2020
What’s at Stake in Debates over Bank Money Creation Mechanics?
Morgan Ricks, Vanderbilt Law School

January 15, 2020
Are Banks Special? A Fintech Perspective
Charles M. Kahn, University of Illinois

January 08, 2020
Endorsing the Money-creation View
Marc Lavoie, University of Ottawa