Question

1."Money is debt." Critically evaluate.

2.Banks are more likely to create M-1 when the economy is expanding than when it is experiencing a recession. Do you agree or disagree? Why?

Answer 1

1. 1. BANKS CREATE NEW MONEY WHEN PEOPLE GO INTO DEBT

When you take out a loan, new money is created. As people borrow more, more new money comes into the economy. All the extra spending this newly created money funds gives people the impression the economy is doing well, which encourages them to borrow even more. As the debt goes up, so does the amount of money.

2. FOR EVERY POUND OF MONEY, THERE’S A POUND OF DEBT

Because banks create money when people borrow, for every pound of money in the economy there will be a pound of debt. If there’s £100 in your bank account, someone else must be £100 in debt. Across the whole economy there will be as much debt as money.

3. IF WE WANT MORE MONEY IN THE ECONOMY, WE HAVE TO GO FURTHER INTO DEBT

If we need to get more money into the economy – for example, during a recession – then we have to go further into debt to the banks. This is why the government is desperate to get banks lending again: if banks start lending more, they’ll create more new money in the process, and the people who borrowed will spend this new money.

4. IF WE TRY TO PAY OFF DEBT, THEN MONEY DISAPPEARS

When you pay down your debts, the money that leaves your bank account doesn’t go to anyone else – it just disappears. This is because loan repayments are just the opposite process to money creation: banks create money when they make new loans, and effectively ‘destroy’ money when they repay loans.

So when lots of people try to pay down their debts at the same time, money disappears from the economy. As a result of there being less money and less new lending spending slows down. When this happens, it’s like draining the oil from the engine of a car: pretty soon, everything stops working.

2. Yes i agree due to the following reasons:

The money multiplier will depend on the proportion of reserves that banks are required to hold by the Federal Reserve Bank. Additionally, a bank can also choose to hold extra reserves. Banks may decide to vary how much they hold in reserves for two reasons: macroeconomic conditions and government rules. When an economy is in recession, banks are likely to hold a higher proportion of reserves because they fear that loans are less likely to be repaid when the economy is slow. The Federal Reserve may also raise or lower the required reserves held by banks as a policy move to affect the quantity of money in an economy, as Monetary Policy and Bank Regulation will discuss.

The process of how banks create money shows how the quantity of money in an economy is closely linked to the quantity of lending or credit in the economy. Indeed, all of the money in the economy, except for the original reserves, is a result of bank loans that are re-deposited and loaned out, again, and again.

Finally, the money multiplier depends on people re-depositing the money that they receive in the banking system. If people instead store their cash in safe-deposit boxes or in shoeboxes hidden in their closets, then banks cannot recirculate the money in the form of loans. Indeed, central banks have an incentive to assure that bank deposits are safe because if people worry that they may lose their bank deposits, they may start holding more money in cash, instead of depositing it in banks, and the quantity of loans in an economy will decline. Low-income countries have what economists sometimes refer to as “mattress savings,” or money that people are hiding in their homes because they do not trust banks. When mattress savings in an economy are substantial, banks cannot lend out those funds and the money multiplier cannot operate as effectively. The overall quantity of money and loans in such an economy will decline.