Premium
MONEY CREATION AND THE THEORY OF THE BANKING FIRM
Author(s) -
Towey Richard E.
Publication year - 1974
Publication title -
the journal of finance
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 18.151
H-Index - 299
eISSN - 1540-6261
pISSN - 0022-1082
DOI - 10.1111/j.1540-6261.1974.tb00024.x
Subject(s) - watson , corporation , state (computer science) , citation , associate editor , law and economics , management , classics , history , library science , economics , law , political science , computer science , artificial intelligence , algorithm
ONE OF THE MOST widely accepted propositions in economics is that total demand deposits of commercial banks are determined by the quantity of cash reserves and the reserve ratio. The multiple expansion process is described, albeit in simplified form, in every principles textbook. In more advanced treatments, this "pure theory of fractional reserve banking" is extended to incorporate reserve leakages to currency and other forms of deposits, desired excess reserves, differential reserve requirements, etc. But even with the elaborate specification and testing of money supply theory by Brunner [6], Cagan [7], Friedman and Schwartz [10] and others, there is growing dissatisfaction with this type of analysis. To a large extent, this arises because private bank responses are treated as almost trivially mechanical. They may, -as the theory posits, be able to force deposits on the general public equal to some precise multiple of reserves under certain conditions. Alert students soon recognize the irony, however, that when shifts to currency or to banks with different reserve ratios are permitted, it is apparently the behavior of the general public which determines total deposits from a given monetary base. Even the size of each bank depends on the public's whim from this perspective. The theory of money creation has rightly been criticized by Gurley and Shaw [13] and Tobin [27] for ignoring that banks are firms. It should be possible to describe bank operations explicitly with the same models of the individual firm and industry as are used with other producers. A more adequate description of bank reactions can then help in clarifying these puzzles in the money creation process. Other micro models of banking following lines which are more or less familiar for nonbanking pursuits have been presented recently. Klein's model [17] was for purposes other than reconciling the theory of money creation with the theory of the firm. Pesek [20] had this as one of his objectives, but his paper and the present one differ, among other ways, in certain matters of emphasis.1 The tasks here are to show that, rather than being determined one-sidedly, the equilibrium money stock results from meaningful interaction of the public's tastes with the price-output decisions of individual banks and