How Banks Create Money

In: Business and Management

Submitted By peppaseed
Words 369
Pages 2
Hello Professor and Class,

Banks create money by accepting deposits and making loans, this make the money supply larger than just the value of currency in circulation. (Krugman & Wells Pg. 392) For example if I had $800 cash at home and decided to put it in the bank (I now have a checkable deposit), the bank turns around and loan someone $500 out of the money I deposited and a percentage is put in reserves. That person now has $500 cash in which they spend $400 at a Kay’s Jeweler. Kay’s Jeweler deposits the $400 to the bank and the bank lends $350 to another borrower and put a percentage in reserves.
The impact creating money has on the economy during an inflationary gap can cause locally produced items to be less expensive, which can have a positive impact on a country’s trade deficit. But in the long run the economy will increase consumption causing prices to increase too. Creating too much money can also cause the devaluation of our currency which in turns causes imported items to be more expensive.
The impact creating money has on the economy during a recessionary gap can prove to be beneficial in stabilization of the economy. Creating money will lower interest rates which will encourage people to spend again. More money being spent will boost business which in turns stimulates the economy. Demands will be higher than supply which is great for the unemployment rate because it will decrease due to people working.
During a recessionary gap banks can contribute to the recovery of potential output by giving loans to business owners to keep operations going and personal loans for households to thrive in this difficult time. The banks are investing in businesses because they rely on them to generate money to put back into the economy. The reason for personal loans is for the individual to spend more. Although they are contributing they are also hindering…...

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