Can Banks Individually Create Money Out of Nothing? – The Theories and the Empirical Evidence

By R. Werner. 2014

297 citations recorded by the source corpus.

Abstract This paper presents the first empirical evidence in the history of banking on the question of whether banks can create money out of nothing. The banking crisis has revived interest in this issue, but it had remained unsettled. Three hypotheses are recognised in the literature. According to the financial intermediation theory of banking , banks are merely intermediaries like other non-bank financial institutions, collecting deposits that are then lent out. According to the fractional reserve theory of banking , individual banks are mere financial intermediaries that cannot create money, but collectively they end up creating money through systemic interaction. A third theory maintains that each individual bank has the power to create money ‘out of nothing’ and does so when it extends credit (the credit creation theory of banking ). The question which of the theories is correct has far-reaching implications for research and policy. Surprisingly, despite the longstanding controversy, until now no empirical study has tested the theories. This is the contribution of the present paper. An empirical test is conducted, whereby money is borrowed from a cooperating bank, while its internal records are being monitored, to establish whether in the process of making the loan available to the borrower, the bank transfers these funds from other accounts within or outside the bank, or whether they are newly created. This study establishes for the first time empirically that banks individually create money out of nothing. The money supply is created as ‘fairy dust’ produced by the banks individually, "out of thin air".

Subfields: Accounting, Economics and Econometrics, Finance

View Paper: https://www.semanticscholar.org/paper/7757acbc1f784ab29d46745213d68d84eccc7bbe

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Citations in the corpus

Agent based-stock flow consistent macroeconomics: Towards a benchmark model (2016, background): “…example confirms the topicality of the arguments proposed in order to justify our modelling approach and stress the pivotal importance of the credit creation theory of banking in a macroprudential policy perspective, in line with the recent empirical evidence provided by Werner (2014, 2015).”
From financial instability to green finance: the role of banking and credit market regulation in the Eurace model (2019, background): “…the relevant features needed to address our research question, such as the endogenous nature of money created by the banking system in modern economies, see e.g. McLeay et al. (2014); Werner (2014), and the non-equilibrium evolutionary dynamics of the economy (Kaldor (1972); Arthur (2006)).”
Does Foreign Direct Investment Generate Economic Growth? A New Empirical Approach Applied to Spain (2018, methodology): “The illusion is designed to allow the early movers in this pyramid scheme to sell out to the late-coming—usually retail—investors, who will bear the brunt of the losses; ordinary taxpayers are usually and unnecessarily made to pay for the subsequent bank bailouts; Werner 2014b).”
A lost century in economics: Three theories of banking and the conclusive evidence☆ (2016, background): “The overview of the literature on how banks function, in this paper and in Werner (2014b), has revealed that economics and finance as research disciplines have on this topic failed to progress in the 20th century.”