Abstract of "Money Creation in the modern Economy"

Money Creation in the Modern Economy Student’s Name Institutional Affiliation Money Creation in the Modern Economy In the current economy, broad money is the sum of money held in companies and households. The article provides an overview of how money is created in the current economy. In the current economy, money creation has been understood to have two misconceptions. Money is thought to be created when banks lend out money to borrowers as a loan. By doing this, banks act as intermediaries between the savers and the borrowers. Another misconception is that the central bank is in control of the number of deposits and loans availed in the economy. The central bank chooses the number of reserves in order to implement monetary policy through the ‘money multiplier' approach. Normally, money and banking are introduced in the economic textbooks through the money multiplier approach. This theory is not an accurate description of money making in the current economy. So, the commercial bank can create bank deposits but it is not responsible for fixing the reserves available (McLeay, Radia, & Thomas, 2014). In reality, money is created through the back deposits by commercial banks. These are created and destroyed whenever the banks give loans which are later repaid back by the clients. This occurs when the banking sector buys and sells existing assets from consumers, companies or the government. There exist three constraints that restrict the sum of money created by the commercial banks, which include households and businesses, the bank, and the monetary policy. Market forces limit the amounts individual banks are allowed to lend out. Normally, the monetary policy can respond to such restrictions by reducing the policy rate to boost money creation. Commercial banks pay interest on liabilities such as savings accounts as well receive interest from payments of assets such as loans. There ar...