Endogenous Money Or How Loans Create Deposits

If you open any economic textbook you will find a standard explanation of how banks operate. The basic story is that a person deposits some money (say €100) into a bank which then saves a percent of this (say 10%) as a reserve and then lends out the rest. This €90 is then deposited by whoever receives the loan, 10% of which is saved and the rest is lent out. This goes on and on until the original €100 has become €1,000. It is easy to see why students are told this story; it is simple, intuitive and gives them a basic idea of banking. Unfortunately, it is wrong.

There is strong evidence that contrary to the above story (known as the loanable funds theory) the banking system works the other way around. Deposits don’t create loans; loans create deposits (this is known as endogenous money). This is a more complicated story but a more realistic one that can better guide our view of the economy. Continue reading “Endogenous Money Or How Loans Create Deposits”

Where Does The Price Come From?

Even though prices are an essential part of the economy, surprisingly little effort goes into researching them or attempting to understand how they are set. The standard economics textbook gives only the briefest mention to the factors involved in their level. The standard summary is that prices are set in response to demand and supply. However, lately I’ve been thinking that this doesn’t quite make sense. The price of ice cream is the same in winter (a time of exceptionally low demand) as in summer (a time of exceptionally high demand). Pubs and restaurants usually charge the same prices during the day and mid-week (when they’re quiet) as during the night and on weekends (when they’re packed). In fact they seem to follow a policy of rationing space rather than allowing the price mechanism to adjust and convey information.

My epiphany came to me as I was wedged at the bar where I had been waiting for half an hour trying to order a drink during Black Monday. Why didn’t the student bar just raise its prices to deal with the excess demand which they knew would occur (as it did every year)? Why did they opt for an option that any first year economics student is taught is highly inefficient? Continue reading “Where Does The Price Come From?”

Guide To The Economic Schools Of Thought

Economics is not a homogenous or unified subject, rather there are a series of competing ideas over the key areas. These ideas can be roughly divided into several schools of thought and I’ll give a guide to them here. It is the great myth that economists pretend to be non-partisan when in reality we all have our own biases and opinions. It is impossible to study a topic without forming an opinion of it and economists are no exception. So by understanding the different schools of thought you can not only understand why economists give different and contradicting policy advice but also how they see through different lenses. Continue reading “Guide To The Economic Schools Of Thought”