Article Review Sample: Loanable Funds vs. Money Creation in Banking: A Benchmark Result

Published: 2022-05-06
Article Review Sample: Loanable Funds vs. Money Creation in Banking: A Benchmark Result
Type of paper:  Critical thinking
Categories:  Banking Money
Pages: 7
Wordcount: 1888 words
16 min read

Main Arguments in the Paper

In the article, "Loanable funds vs. money creation in banking: A benchmark result", Faure & Gersbach offers a comprehensive exposition of the differences as well as the relationship that exists between the loanable funds and the money creation. Faure & Gersbach (2017) attempts to offer the description of which circumstances does the money creation and loanable-funds approaches yield the same outcomes. In fact, they establish a simple benchmark result. In the absence of uncertainty and thus prove that there is no bank default or loss as both processes yield the same. In the paper, Faure offers the exposition of the concepts of the money creation theory and the loanable funds and provide a unique approach on attaining the equilibrium monetary flow within the economy. These models, according to Faure & Gersbach (2017) provides results similar at every given points of the years regardless of the trending uncertainties in the market. Shockingly, the money creation approach has escalated the creditworthiness of the banks borrowers which has a great impact on the outstanding amount in the in the banks in relation to the loanable funds. From deep investigation of these models demonstrates that the equilibrium states can be attained even if the prices keep on fluctuating. On the other hand the money creation by the banks is comprehensively bounded and when the monetary systems breaks down then the end results will be restoration of the original equilibrium on the best monetary allocation just like in the loaning funds.

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Faure & Gersbach (2017) further recognizes that on a close analysis on the general equilibrium models, the household consumptions on the physical goods and the production sectors over a long period of time. They argue that the amount of the unconsumed goods within that stipulated period of time, upon the consumption the amount of the physical good s which remains at the beginning of the same period shows that the banks are then exchanging the equity contracts against some amount of the physical goods to be used in the money creation models. In the second account, when the banks pays the households with the dividends from the properties. The limited liabilities tend to protect the banks and their entire shareholders making some banks not to pay their depositors. Notably, the households being fully insured by the government making the banks defaulting against the shareholders are then bailed out by the shareholders without massive taxation. Following this approach it is clearly evidence d that both the loanable funds and the money creation approach by the banks yield the same allocation within a stipulated period of time.

I agree with the Faure & Gersbach's arguments in regard to the loanable funds and money creation in the banks. In my view, the extensions of money by banks facilitate the creation of credits on consumers. The loanable theory basically focuses on the market interest rates by determining the all forms of credits as well as the loans, the bonds and the saving deposits in the banks. Notably the degree to which Faure & Gersbach supports the tenets of theory is considerable. Notably, apparently, the availability of the credits in the economy is greatly influenced by the ability and the propensity to invest and save the funds available. However the banks do acquire loans to fund banks operations and the bond market, respectively. In the loanable-funds approach, the households' savings in the form of bank deposits and bank equity are lent out the pirate and the public. In the money-creation approach, however, bank lending creates the deposits that are essential for households to invest in bank deposits and bank equity.

Further, I believe that the equilibrium market interests is only attainable when the banks creates the credit programs and make the funds available to the public by ensuring the private savings is at par with the money available in the economy. Faure & Gersbach (2017) has tremendously captured this in his paper. In fact, concept of the money creation entails a mechanism where the m monetary supply of country or a region increases within a given period of time. In addition, the monetary supply is generated from the bank's deposits and periodically monitored by the central bank. From an in depth economic analysis the relationship between the loanable and the money created funds register the same allocation in the banks regardless on the rising uncertainties' thus no banks defaults. Finally, as a model, the loanable funds tends to focus on the micro and other macro elements where the banks receives the finances from equity and other financial contracts and lend out to the simultaneously creates the deposits. Faure & Gersbach explicitly offers the explanation about this. Alternatively the firms use the deposits to buy in investments goods which are deposited to the housie holds which determine the assets they wants to hold within a given period of time. On the other hand the house hold purchases the consumption goods which are then transferred to the banks and thus repay the loans. This concept helps creates the money in the banks known as the money creation concept.

Finally, the commercial banks create money through bank deposits and establishing new loans. For example, this can be made possible for an individual taking out a mortgage to purchase a house. Under these circumstances, the banks does not create credit by awarding thousands of money but credits customer's bank account with bank deposits of mortgage sizes. In addition, any move by the bank to gives a new loan, it creates a new money and debt. In the recent times, commercial banks have raised the amount of money in circulation by giving out the loans to people leading the rise of products over a considerable period of time.

Why the Neoclassical Economists do not Understand Faure & Gersbach Ideas

In as much as Faure & Gersbach (2017) attempt to offer the relationship between the loanable funds as well as the money creation in the economy, the neoclassical economists do not understand it. In fact, the neoclassic theory of the loanable funds perceive banks as barter institutions that intermediate deposits of the pre-existing real loanable funds between the borrowers and the depositors. This view, however, has one huge problem. Primarily, there is no pre-existing loanable funds in the real world and the Intermediation of Loanable Fund (ILF) do not exists (Akram, 2009). Rather, the banks are involved in the creation of the new funds as a matter of lending, through matching loan and deposit entries, both in the name customer, on their balance sheets. In the same way, the neoclassic economists believe, in relation to the money creation and loanable funds, that goods market are brought into equilibrium by the rate of interests. On a broader note, they believe that at equilibrium, the interest rate, r, aggregate demand equals to aggregate supply and the investment equal saving and demand for loanable funds equals the supply of the loanable funds. This view is wrong.

In what appears to be an adequate explanation about the manner in which the money is created in the modern fiat money system, this explanation, as part of the neoclassic economic theory. In fact, one major misconception and misunderstanding of the neoclassical economics believe that banks just acts as the intermediaries, who are only involved in the lending out of the deposits that savers place with them. This view further perceive the deposits as typically being created through saving the decisions of the households and the banks later 'lend out' those existing deposits to borrowers that may include the companies that look for finance investments or the individuals who want to buy houses. Undeniably, any move by the households to choose to save more money in bank accounts makes the deposit come simply at the expense of money that would have otherwise be channeled to the companies in the payment for the good services. Savings in this case does not increase the deposits or the 'funds available' by itself, for the banks to lend. In this sense, therefore, the move to view banks as mere intermediaries as the neoclassic economist do tremendously ignores the fact that commercial banks are the actual creators of the deposits. The contemporary or endogenous money theory believe that the commercial banks, as financial intermediaries, have the ability to create money. In fact, through lending money that they do not actually possess still constitutes to issuing of money. This can be well explained especially whenever the bank makes a loan whereby it simultaneously creates a matching deposit within the borrowers bank account. This process creates new money. In as much as the commercial banks create money by lending, the degree of such lending activities are however by prudential regulations, which exerts problems as the mechanisms of keeping or maintain the resilience of the financial systems (Coppola, 2014).

In another view, the neoclassical economists substantially relates the "money-multiplier approach" to money creation, and therefore presumes that the determination of the loans quantity and deposits in the economy are conducted by the central banks through controlling the quantity of central bank money. In regard to this perspective, it is the responsibility of the central banks to conduct the implementation of the monetary policies and this happens through choosing quantity reserve. Based on the assumption that there exists a constraints of broad money to base money, these reserves are subjected to multiplication to a considerably greater change in bank loans as well as deposits. In order for this theory to hold, the quantity of reserves must demonstrates some bonding to the constraint on lending. In addition, the central bank must directly conduct a determination of the reserve amount. The credit view of monetary policy holds that one mechanisms through which the changes of bank reserves can influence the actual activities is through affecting the quantity of funds that commercial banks have to lend b(Coppola, 2014).. Undeniably, these can be primarily accomplished through the variation of the reserve requirements of the banks. Notably, the high ratio of the reserve have been shown to lower the quantum of funds that is available for the onward lending and vice versa. While it is evident that the money multiplier technique is vital in enhancing the understanding the manner in which the reserve amounts are determined, it does not explain the description of the way money is created in the real world (Goldsmith, 2015).

The banks practices that occur nowadays highly differ from those seen few decades ago in regard to controlling the quantity of reserves. Nowadays, the central banks typically implement monetary policy through setting the reserve price, implying the interest rates. Coppola (2014) reported that the view that the quantity of reserve created drives the loan amount by bank is undeniably problem. In fact, this is one of the assumptions that the neoclassical theorists hold and therefore do not understand the concept of loanable funds and the money creation in banks (Rochon, 2003. As an elaboration, the decisions by the banks to lend money depend on the availability of the profitable lending opportunities in a particular time period. The process of lending is facilitated by the risk appetite of the bank. In fact, they lend when the risks or the return profile prevails in their favour. In the situation whereby this is not the case, no amount of extra reserve creation will propel the banks to lend.

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Article Review Sample: Loanable Funds vs. Money Creation in Banking: A Benchmark Result. (2022, May 06). Retrieved from

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