Central Bank theories of Banking and Money

The suppression of the credit creation theory of money obscures the fact that each bank adds with every credit extension new money in the economy.

In this article, Perry Mehrling, a professor of International Political Economy at Pardee School of Global Studies, Boston University, discusses three theories of banking which are guiding bank regulation and research. These are credit creation theory, fractional reserve theory and debt intermediation theory.

By analysing a paper of Richard Werner, which criticizes the suppression of the classic view of money creation, he asks the question whether these three views are really mutual exclusive. To prove his point, he extends Werners reasoning to show that both views are true in specific cases. While one is focused on the initial payment the other is focused on the ultimate funding.

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Comment from our editors:

The understanding of how Banking actually works is hugely important and something many economists are not clear about. Regarding the three competing monetary theories, this article is more a discussion about their compatibility than an overview.

For an overview see Mehrlings Coursera MOOC titled “The Economics of Money and Banking”, which has been a huge success in the sense of being watched by tens of thousands of people and is also linked on Exploring Economics.

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