When a bank makes loans, it creates money.McConnell expects his reader to find this "a startling fact." (I remember being startled by it, back in 1977.) And this:
It is through the extension of credit by commercial banks that the bulk of the money used in our economy is created.He calls it "bank money." And this:
It seems logical to inquire whether money is destroyed when the loans are repaid. The answer is "Yes."
I have three thoughts:
1. On the internetMost of the time when I see the "banks create money" idea on the internet, it is associated with the phrase "fractional reserve banking" and seems to be considered some sort of criminal activity.
I won't argue the point, except to say I don't see how it could be criminal, since it is common and public and built into the institutions and the fabric of society. And it's not some great secret kept hidden from everybody; all you have to do is take an economics class to learn about it.
Anyway, the problem is not that banks create money and debt. The problem is the excessive accumulation of bank-money or credit-money or debt, relative to the quantity of M1 (money in circulation).
2. What happens to a dollarWhat happens to a dollar of bank money during its lifetime? It works just like real money (because it is money). Maybe it was your boss who took out the bank loan, to meet payroll. So, you get paid this week with "bank money." Maybe cash, maybe payroll check, maybe direct deposit, it's still bank money, created when your boss borrowed it.
Do you feel cheated? I don't see why. Would it be better if the boss gave you a hand-written IOU or a verbal promise to pay you in a week or two? I don't think so.
It doesn't matter that the money you receive may have been created that very day by a bank lending it to somebody. In fact, it has probably happened to you without your even knowing about it.
3. Like the FedAcross the top of a dollar bill it says "Federal Reserve Note." The dollar is issued by the Federal Reserve. The Federal Reserve is called "the Fed."
Picture the Federal Reserve buying assets from the public. The sellers receive "new" money for the assets they sell. That money stays in the economy until the Fed starts to worry about inflation, and decides to sell some assets and take money out of the economy again.
Picture me borrowing money from the bank. It's new money we create, the bank and I, and when I receive that money and buy something, I'm putting new money into the economy. Exactly like the Fed does.
When I make a payment on that debt, I capture circulating money and take it out of the economy again. Exactly like the Fed does. If I choose to make only the minimum payments, the money I put into the economy stays in circulation for a long time. Only when I take a dollar and use it for debt repayment -- only then -- does my money come out of the economy. Just like at the Fed.
We are, each of us, a little version of the Federal Reserve.