Endogenous money creation and Fraction Reserve Banking

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    Got into a discussion with someone who basically equated Endogenous money creation with Fractional Reserve Banking.

    There was two parts to the discussion. One, how does a 100% reserve bank create money? Two how does me borrowing from my buddy create money?

    In response to the first, the claim was made that a 100% reserve is unreachable and therefor even a 100% reserve bank would create money. This person also claimed endogenous money was an Austrian theory (and subsequently called me a ‘sheep’ for not knowing that it was). I know Rothbard (and probably others) advocated a 100% reserve bank, but I don’t know how to respond to the claim that achieving 100% is impossible.

    The second was that if I borrow 20 dollars from my buddy, this creates money. This is because I now have 20 dollars, and my buddy has “credit money”, or a note that represents my future money when I pay it back. Both of us take the dollars and the credit money to the store and buy $40 dollars worth of goods for the storekeeper accepted my buddy’s $20 dollar credit money and also my $20 dollars.

    Because this resulted in $40 dollars of value being moved around, isn’t this money creation?

    My response to this was simply that it wasn’t money “creation” but rather a transfer of value from the future to the present. For when I pay back the loan to the storekeeper who holds my debt, I no longer have 20 dollars that I otherwise would have used to buy $20 dollars of goods from the storekeeper’s store. Therefor, the storekeeper may have moved $40 dollars of value in the present, he will have lost $20 of it in the future when the loan is repaid.

    Is this plausible?

    Seems like I’ve got a long way to go in the Austrian school, but I’m excited every step of the way.



    Without the Federal Reserve, government deposit insurance and other regulations the reserve ratio set by the market would probably be very high (perhaps though not 100%). This would probably be the case if fractional reserve banking was legal.

    But there’s a great debate among Austrians if FRB should also be legally prohibited because it can be considered fraudulent and an infringement of property rights. If it were illegal, a 100% reserve ratio would be required.

    (A bank following a 100% reserve ratio, would not be able to create money out of thin air and thus increase the money supply.

    I’m sure you can find articles on this topic on mises.org

    I’ve never heard of endogenous money and I’ve read lots of Austrian literature. The Wikipedia Article on endogenous money states that the concept was explained by Irving Sisher, a neo-classical economist, not an Austrian.

    I’m not sure about the second part of your questions. It seems to me you’re confusing the scenario in the example with fractional reserve banking. (I’m also not sure if a store would accept the ‘credit money’.)

    In the case of FRB, if I deposit $500 in a bank and the reserve requirement ratio is 20%, then the bank can loan out additional $400 (80% of $500). I would be able to withdraw the $500 from my checking account. The receiver of the $400 credit loan is of course also able to spend that money. So the money supply has increased from $500 to $900. If the loan is payed back, the money supply shrinks back to $500.

    I hope I could help a little bit


    The concept of endogenous money is post-Keynesian, not Austrian.


    The Austrian Free Bankers have the concepts of Inside Money and Outside Money.


    There are some alleged affinities between Post-Keynesians and Austrians because they both criticize neoclassical general equilibrium.


    But the Post-Keynesian conception of endogenous money is traceable to Hyman Minsky and by association, Joseph Schumpeter.


    Here’s a commentary on the “debate” between Krugman, who is a New Keynesian, and Minsky, who is a Post-Keynesian.


    In answer to your first question, not only is 100% reserve possible, but it was realized in history. For example, the Amsterdam banks of the 1600s were 100% reserve.

    In answer to your second question, money substitutes are claims to money payable on demand at par. These are part of the money stock. In contrast, claims to be paid money in the future are credit claims. Normally credit claims do not function as a medium of exchange. Your buddy’s IOU would not be accepted by merchants as a medium of exchange, i.e., the most salable good in the market, under normal conditions. So, credit that comes from someone’s saving does not create money.

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