IT SAYS IN MY ECONOMICS TEXTBOOK THIS: "NOTICE THE MONEY SUPPLY HAS INCREASED.WHEN JENNY BORROWED 900 AND THE BANK PUT THAT AMOUNT IN HERCHECKING ACCOUNT,NO ONE ELSE IN TH ECONOMY HAD ANY LESS...

IT SAYS IN MY ECONOMICS TEXTBOOK THIS: "NOTICE THE MONEY SUPPLY HAS INCREASED.WHEN JENNY BORROWED 900 AND THE BANK PUT THAT AMOUNT IN HER

CHECKING ACCOUNT,NO ONE ELSE IN TH ECONOMY HAD ANY LESS MONEY, AND JENNY HAD MORE THAN BEFORE. CONSEQUENTLY, THE MONEY SUPPLY HAS INCREASED." BUT THIS DOES NOT MAKE SENSE BECAUSE PERSON A HAS LESS MONEY BECAUSE  HIS MONEY WAS USED FOR THE LOAN! IS THIS CORRECT?

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pohnpei397's profile pic

pohnpei397 | College Teacher | (Level 3) Distinguished Educator

Posted on

No, it is not correct.  Your book is right.

When the bank loans money out to Jenny, she has money that did not exist before.  Presumably your book mentions some other person who deposited probably $1000.  We'll call him Chuck.  When the bank gave $900 to Jenny, they did not take money out of Chuck's account.  He still has $1000 in the bank.

If they took his money and lent it, they would not be creating money.  But they did not take his money.  They created new money based on his deposit -- secured by his deposit.

If the bank actually took away your money and lent it to someone else, no one would ever put money in the bank because it would be too hard to know when you would be able to get that money out.

krishna-agrawala's profile pic

krishna-agrawala | College Teacher | (Level 3) Valedictorian

Posted on

In economics money supply refers to the total amount of  money that is being used by individuals and businesses for their buying and selling activities. This is distinct from money that has been put away as savings to be used sometime later. The money which has been put away as saving and remains there, is currently not in circulation, and therefore not a part of money supply.

The money with banks include the money owned by them as well as the savings of people deposited with them. As long as this money is with the bank it remains out of the cycle of money supply. However, banks do not keep all such money with them. A substantial amount is given out to individuals and businesses as loans. This puts back the amount loaned in the money supply stream.

Thus money supply decreases when people save money and put it in the banks. The money supply also decreases when people repay to banks the loan taken by them. Similarly money supply increases when they withdraw their savings from bank or borrow money from them.

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