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Can banks individually create money out of nothing? — The theories and the empirical evidence

Can banks individually create money out of nothing? — The theories and the empirical evidence
Can banks individually create money out of nothing? — The theories and the empirical evidence
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".
bank credit, credit creation, financial intermediation, fractional reserve banking, money creation
1057-5219
1-19
Werner, Richard A.
dc217378-eb19-4592-9be4-ab5f847b74a1
Werner, Richard A.
dc217378-eb19-4592-9be4-ab5f847b74a1

Werner, Richard A. (2014) Can banks individually create money out of nothing? — The theories and the empirical evidence. International Review of Financial Analysis, 36, 1-19. (doi:10.1016/j.irfa.2014.07.015).

Record type: Article

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".

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1-s2.0-S1057521914001070-main.pdf__tid=41ad9a40-87c8-11e4-ad9d-00000aab0f26&acdnat=1419025669_0bbd3a453ffe29a8b14cdd91e676c8d8 - Accepted Manuscript
Restricted to Repository staff only until 30 November 2017.
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More information

e-pub ahead of print date: 16 September 2014
Published date: December 2014
Keywords: bank credit, credit creation, financial intermediation, fractional reserve banking, money creation
Organisations: Centre of Excellence for International Banking, Finance & Accounting

Identifiers

Local EPrints ID: 372866
URI: https://eprints.soton.ac.uk/id/eprint/372866
ISSN: 1057-5219
PURE UUID: f1229085-c39f-4c1b-9bfc-bff7df62818c

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Date deposited: 23 Dec 2014 16:36
Last modified: 21 Oct 2019 19:17

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