Myths about Money you must know

Here are some common misconceptions.

  • Banks lend money that they receive from depositors.
    When banks issue loans, they create new deposits without disturbing existing deposits. This is what causes the money supply to grow and it is what separates bank lending from other types of lending. A non-bank lender (like a finance company) will only lend what is sitting in the bank. It can’t create new deposits like a bank can.

  • The government sometimes prints too much money and causes inflation.
    The government only prints money to meet the demand for currency. These notes are issued to banks in exchange for deposits the banks have to hold with them, that is, the Federal Reserve Bank. The public receives these notes in exchange for their deposits at the bank. The amount of money issued is no more, and no less than the public needs to hold in their wallets, or for a rainy day. It should have no bearing on inflation.

  • Bank reserves ensure there will be funds available for depositors.
    Each bank has to hold a minimum reserve of money with the Federal Reserve Bank. This used to be viewed as a protection for depositors. Banks need to hold sufficient reserves themselves to cover withdrawals by their depositors. A bank who is temporarily short of reserves can borrow from the Federal Reserve Bank.

  • Government deficit increases the money supply.
    Deficit spending increases the financial wealth of the private sector in the form of securities rather than money. Every dollar that the treasury spends is money previously created by the Federal Reserve Bank.

  • An excess supply of money causes price inflation.
    Money exists in the form of bank deposits which are created when the banks issue loans. Money growth depends on the demand for those bank loans and the willingness of the banks to lend. The Federal Reserve Bank can influence the demands through its control of the interest rates but it cannot control the amount of lending. If the interest rate is kept down for a period then the amount of bank credit that is issued may grow enough to put upward pressure on prices. However this is seldom the cause of price inflation.

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