real-world economics review, issue no. 97 subscribe for free
How financial bubbles are fueled by money creation a.k.a. bank lending: An explanation for public education Ib Ravn [Danish School of Education, Aarhus University] Copyright: Ib Ravn, 2021
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Introduction It is widely acknowledged that the build-up of a financial bubble coincides with and may even be caused by excessive bank credit or lending (e.g., Reinhart and Rogoff, 2009; Kindleberger and Aliber, 2011; Jordà, Schularick and Taylor, 2015). Equally well understood, at least to the readers of this journal, is the fact that commercial bank lending involves money creation (Werner, 1997, 2014a, b; Ryan-Collins et al., 2011; McLeay et al., 2014; Jakab and Kumhoff, 2019). Somewhat less frequently discussed is the possible causality implied by the conjunction of these two facts: If bank lending really is a process of money creation, and bank lending precedes the bursting of financial bubbles, then money creation by banks may be hypothesized to be a main driver underlying the rise and bursting of financial bubbles (e.g., Werner, 2005; Turner, 2015; Keen, 2017; Huber, 2017a). In this paper I shall proceed from the assumption that future research will bear out this proposed c ec i be ee ba k e di g ( ha i , e c ea i ) a d fi a cia b bb e i f a i g a d b i g . I ead f h i g hi i k be he ca e I i e a hi ica a d c ce a context for it that may help the expert readers of this journal explain it to their students and lay audiences. The inability of most neoclassical economics to embrace this link between money creation and financial bubbles suggests that an alternative, non-neoclassical interpretation of the monetary and banking context is required. Once supplied, such an explanatory context will render the link readily meaningful, even to beginners, and, thus, I hope, contribute to public education (cf. Ravn, 2015). The context to be proposed is that of money being continually created, by such agents as preRenaissance merchants and then by banks and, especially, banks interconnected through clearing systems. This contrasts with the neoclassical narrative that starts with the myth of igi a c ea i , he ba e , a d he a ge f ge ab e c ea i ( he f actional e e e ba ki g de i a fig eaf ha f e ab a d age 700 i A e ica textbooks on economics; it is accorded no theoretical centrality). In what follows, the reader will be reminded of the more plausible genesis of money: Money arose out of informal debt obligations that were gradually formalized and recorded on paper (c e cia a e a d edge b k ). Ea kee e f e e acc di c e ed ha he could extend credit by adding figures to these accounts, thus effectively expanding the money supply and reaping the associated benefits (seigniorage and interest). Next, banks invented means whereby the credit extended to their customers could be used out-of-bank: clearing arrangements at medieval fairs (for bills of exchange), clearing houses in the 19th century (for
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