DSGE
VIP Member
- Dec 24, 2011
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Actually, I think you're concentrating on currency because that's all you can understand. It seems to me that the concept that the banking system can turn $100 of honestly earned labor into $1000, collecting interest at each step is beyond your understanding, because I think the the fact that bankers can create money and earn interest from the privilege would piss off most normal people who understand the system. Not to mention, but the act of creating the money also devalues the labor put into earning the initial $100, because those extra $900 were created without any productive labor, which is inflationary.
Money created by the banking system, what's called "inside money", isn't actually inflationary. What happens when a bank issues bank money (say, a demand deposit)? It ends up in a different bank. I go to the store and buy groceries with my demand deposit; the bank the store uses is usually different from mine. If not, the bank takes the deposit and issues it again. It ends up at some point in a different bank.
Now what does that bank do with it? Does it want to hold some other bank's liability? No. It cashes in that demand deposit for reserves, because it wants to use those reserves to back its own issue of money. Now that the original bank doesn't have the reserves anymore, it has to contract its issues of money which those reserves were backing, else they'll face solvency problems.
So when a bank creates money, is it inflationary? No, precisely because of this competition for reserves. A bank is only able to issue money in excess of its reserves because the public's demand for money allows it to not be spent and immediately redeemed for reserves. Moreover, when the publics demand for money increases, the amount of money banks can safely issue increases; and vice versa. So the quantity of inside money increases or decreases endogenously to the publics demand for money. It automatically preserves equilibrium in the money market. So it's not inflationary.
What's inflationary is when banks can issue money in excess of the public's demand for money; and that only happens when the total quantity of bank reserves, that is, "outside money", increases.