WHEN BANKS "CREATE MONEY," DON'T THEY, IN REALITY, JUST RECYCLE THE MONEY AROUND?no new money (cash) has been created.  People are  taking money from the bank and putting it right back in. The...

WHEN BANKS "CREATE MONEY," DON'T THEY, IN REALITY, JUST RECYCLE THE MONEY AROUND?

no new money (cash) has been created.  People are  taking money from the bank and putting it right back in. The balance sheet grows as the amount of loans and deposits rise, but the amount of cash in the system remains the same?

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pohnpei397's profile pic

pohnpei397 | College Teacher | (Level 3) Distinguished Educator

Posted on

Especially in today's world, the amount of cash in the system is relatively irrelevant to the concept of money supply.   We use electronic transactions for so many things that the amount of cash compared to the amount of liquid money is really quite small.  So I would say you should not think about cash in this context.

When banks create money, they really create money.  When I deposit my money and they loan some of it out to you, there is more liquid money than there was before they loaned it to you.  It is not just recycled.

If I deposit $1000 from a paycheck and $900 of it gets loaned to you, where did that $900 come from?  It's not coming out of my money because I still have $1000 in the bank.  It's not coming out of the money that anyone else has -- the loan to you does not decrease the balance in the account of any other depositor.

So you can't say it's recycled -- it is new money created by the loan.

The actual physical cash is, of course, recycled.  And banks don't create physical cash.  But they do creat money.

krishna-agrawala's profile pic

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

Posted on

Yes, in a way, you can say that banks recycle money. Although I will not that word "just", which creates the impression that this is something quite unimportant. Fact is that the banks play a very important function in any economy be channelising the savings of individuals for use by businesses and other individuals who require the money now and are able to repay it later. In this way the banks help to increase the economic activity that increases the total GDP of the society.

Also, amount of cash, that is the amount of money in form of currency notes and coins, is also not a true measure of the wealth created by the bank, either for itself or for others. Banks do help in creation of wealth in several ways, but it is not necessarily in form of cash. Banks create wealth for itself in form of profit it earns. It creates wealth for its depositors in form of interest that it pays to them. And it creates wealth for the borrowers in the form of profits earned in business using the borrowed money.

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