No abstract

No abstract

No abstract

We study today’s two-tier money creation and destruction system: Commercial banks create bank deposits (privately created money) through loans to firms or asset purchases from the private sector. Bank deposits are destroyed when households buy bank equity or when firms repay loans. Central banks create electronic central bank money (publicly created money or reserves) through loans to commercial banks. In a simple general equilibrium setting, we show that symmetric equilibria yield the first-best level of money creation and lending when prices are flexible, regardless of monetary policy and capital regulation. When prices are rigid, we identify the circumstances in which money creation is excessive or breaks down and the ones in which an adequate combination of monetary policy and capital regulation can restore efficiency. Finally, we provide a series of extensions and generalizations of the results.

We establish a benchmark result for the relationship between the loanable-funds and the money-creation approach to banking. In particular, we show that both processes yield the same allocations when there is no uncertainty. In such cases, using the much simpler loanable-funds approach as a shortcut does not imply any loss of generality. When there is aggregate risk with complete contracts and complete markets, we indicate that a restricted equivalence result holds.