5 - Money and Banking

5
Money and banking

Marc Lavoie and Mario Seccareccia
OVERVIEW
This chapter:
• presents the heterodox approach to money and banking and contrasts

it with the mainstream;
• explains why mainstream economists view money as a commodity that

takes on the role of medium of exchange, with banks being intermedi-
aries between savers and investors; while heterodox economists view
money as a means of payment resulting from a balance sheet operation
within a creditor/debtor relation, with banks being creators of money
to finance production;
• focuses on the importance of the creation and destruction of money

by the banking system and on the crucial role played by the interbank
market for funds and the payments and settlement system;
• points out that credit-money creation is demand-led and that the main-
stream supply-determined perspective on bank lending is erroneous
and leads to misguided policies such as the quantitative easing policies
implemented in many countries during and after the global financial
crisis of 2007–08 and during the COVID-19 crisis of 2020–21.
Readers will thereby understand why money is not a scarce commodity

and why the banking sector can create credit-money whose only con-
straint is the demand for loans and the creditworthiness of borrowers.
Readers will also understand why banks are the source of the finance that
initiates the production process, while non-bank financial intermediaries
play a role in bringing together savers and business enterprises that have
already undertaken investment to address their final financing needs
during the reflux phase of the circulatory process.
M4921-ROCHON & ROSSI (2nd edn)_Text.indd 151 25/02/2021 08:09

152 · An introduction to macroeconomics
KEYWORDS
• Commercial banking: Financial institutions engaged in the business of

financing, that is, in a process of making loans, and also accepting deposits
whose overall effect is to create or destroy money.
• Flux/reflux principle: A basic principle in which bank credit advances
constitute the flow while income receipts from these expenditures are
the reflux of a corresponding amount that ought normally to permit the
removal of the original loans from banks’ balance sheets.
• Means of payment: In a non-barter system, a payment occurs using a
third-party liability, namely that of the central bank or a private commer-
cial bank, for final settlement by extinguishing counterparty debt of an
equivalent amount.
• Monetary circuit: The circular process of advancing credit-money and
then destroying an equivalent amount once the borrower is able to recap-
ture the principal of a loan for reimbursement, leading to a closure of the
circuit.
• Payments and settlement systems: National systems for the clearing/
settlement of payments within the banking system, in which proper
functioning of interbank lending/borrowing increases financial stability
through enhanced financial market liquidity, together with a central bank
as lender of last resort.
Why are these topics important?

Banks play an essential role in modern societies because our economies rely
on credit for expansion and for redirecting production. Banks also play an
important role because they are at the centre of the payments system, allow-
ing economic agents to carry out transactions between each other in an effi-
cient way. Banks are also an important cog in the financial system, as they
facilitate speculative operations, a role which is not necessarily a positive
one as it may generate instabilities. This is why banks need to be supervised
to meet desirable social goals, either by the central bank or by some central
regulatory agency. Several proposals are being put forward nowadays in an
attempt to curb the excesses of the banking and financial system, so it is
important to get the fundamentals right when it comes to the roles of banks
and central banks.
The traditional mainstream view

All mainstream economics textbooks introduce money as Adam Smith
once described it, in his celebrated 1776 opus, The Wealth of Nations, as
the “universal instrument of commerce” (Smith, 1776/1937, p. 28), which
was invented in order to facilitate exchange. While someone must have first

Money and banking · 153
conceived and designed the wheels of a cart to make it easier to move goods
and reduce transport costs as individuals sought to trade their commodity
surpluses more efficiently, according to this view, so was money invented
in order to grease the wheels of commerce and to engage with less effort in
commodity exchange.
Hence, just as individuals at some moment in human history came to recog-

nize the benefits of the division of labour and began to ‘truck and barter’, so
it was, we are told, that they eventually began to use certain commodities,
usually precious metals such as gold and silver, in their new role as money.
Money supposedly emerged spontaneously from barter exchange because
of these commodities’ particular characteristics of divisibility, portability,
fungibility, durability and relative scarcity, that allowed them to take on the
role of medium of exchange, unit of account and medium of deferment of
consumption.
As this tale of money emerging from barter exchange is normally told in

mainstream textbooks, money’s origin is explained simply as the natural
outcome of private cost-minimizing behaviour that had nothing to do with
the legal recognition and formal legal actions often taken by the state to
ensure money’s general acceptability.
This traditional perspective, therefore, rests on a particularly antiquated

vision of money. Money is essentially conceived as a commodity, like grain,
cowry shells or metals, whose metamorphosis into a medium of exchange
catapulted this commodity money onto an otherwise pre-existing and pri-
vately organized natural barter system. From this, it follows that money’s
principal purpose was to make this market exchange merely more efficient,
thereby surmounting the obstacle of the double coincidence of wants plagu-
ing less efficient barter economies that preceded monetary exchange.
On the basis of this mainstream narrative on the origin of money and mon-
etary exchange that is told repeatedly in economics textbooks, there is often
also associated the tale of how banks, as particular institutions arising from
this profit-seeking behaviour of individual economic agents, first made their
appearance, and whose history is intertwined with that of money.
Historically, while quasi-banking-related activities of advancing simple credit

appeared almost at the same time that humans began record-keeping, one
of the tales of modern banking institutions as loan makers/deposit takers
and issuers of banknotes goes as follows: banks emerged, we are told, very
late after the Middle Ages owing primarily to the conduct of profit-seeking

goldsmiths, especially in seventeenth-century England. Banks appear in this

traditional story in the following way. As these primitive societies progressed
through market exchange, a portion of this overall stock of money in the
form of precious metals changed hands at a certain annual turnover rate (or
monetary velocity) to acquire and validate monetarily the flow of privately
produced commodities. Within these commodity money economies, these
transactions generated a flow of money income accruing to the various coun-
terparties in the monetary exchange. Individual economic agents receiving
these incomes faced the following options: a portion of this income flow of
precious metals could be re-spent, thereby generating a series of consump-
tion flows per period, while another portion could be saved or accumulated
as liquid holdings, since other forms of financial assets had not yet appeared.
Banks appear as intermediaries in collecting a community’s accumulated

liquid savings for safekeeping, for instance, as represented in the textbooks by
the stereotypical goldsmith bankers of seventeenth-century England. With
time, instead of leaving these stocks of precious metals to sit idle and with-
holding them from circulation, these profit-seeking goldsmiths began to lend
the portion of the community’s stock of commodity money stored in their
vaults. This saving would then be lent to those more enterprising individu-
als seeking to borrow money to undertake investment, by charging them
interest. Since a portion of the investment expenditures would be returning
to the same banks in the form of bank deposits, profit-maximizing banks
would then re-lend this money once again, generating further loans in excess
of the initial bank deposits. The effect would be to create bank money, this
being the difference between the initial reserves of precious metals (or base
money) and the total outstanding deposits, as banks progressively leveraged
themselves in relation to their initial gold reserves, through a process tradi-
tionally referred to as ‘fractional reserve banking’.
Ostensibly, the only constraint on this multiple expansion of bank money envis-
aged within this traditional framework was the desire by profit-seeking banks
to hold idle reserves of this commodity money in their vaults exclusively for
precautionary purposes, and the desire on the part of the public to hold some
cash for day-to-day transactions purposes. Moreover, this leveraged banking
system could only function as long as only a small portion of depositors with-
drew their funds regularly and predictably for transactions needs. Otherwise,
if depositors collectively sought to withdraw their gold all at once, as in times
of financial panic, this banking ‘house of cards’ would collapse. There would
just not be enough ‘hard money’ in the system, owing to the fact that the total
money supply (that is, the coins in circulation and bank deposits) would actu-
ally be some multiple of the initial commodity money that had originally been

deposited for safekeeping. Moreover, whether individuals held bank deposits

or whether they held other forms of bank liabilities, such as privately issued
bank notes, the problem would be the same. Whether it is through deposit
liabilities or private bank notes, as long as individuals were prepared to hold
these two types of bank liabilities (and did not withdraw their precious metal
deposits because of lack of confidence), this would allow a bank to grant loans
in excess of the original commodity money deposits that initiated the process.
In this traditional story, while banks can create bank money as some multiple
of the initial commodity money that was originally deposited in the gold-
smiths’ vaults and that is re-lent over and over through a circulatory process
of deposit/loan expansion, banking institutions are conceived merely as
depositories or storehouses of some pre-existing money that was deposited,
say, for safekeeping (Realfonzo, 1998). Regardless of whether this particular
tale of banking (resting on either commodity money or surrogates of such
commodity money, such as central bank notes) may or may not reflect actual
historical reality, this particular perspective on banks as storehouses, whose
principal function is that of profit-maximizing intermediation between
savers and investors, has changed little in modern times. Instead of resulting
from the depositing of precious metals nowadays, we are told that it results
from the depositing of exogenous base money initially created and issued
by the central bank, which, through bank lending and subsequent deposit
creation, leads to a multiple expansion of the money supply; a relation some-
times described as the base money multiplier. Mainstream theorists would
argue, therefore, that ‘deposits make loans’. Banks are conceived as passive
deposit takers that serve the useful function of intermediaries, namely private
institutions whose purpose was to transfer depositors’ money (supplied by
households that save) to creditworthy borrowers who would use those liquid
funds for investment (traditionally business firms seeking credit advances).
This is depicted in Figure 5.1, with investment being determined by the rate
of interest in the market for loanable funds.
Income Flow
HOUSEHOLDS FIRMS
Deposits BANKS Loans
(SAVING) (INVESTMENT)
Figure 5.1 The mainstream conception of banks as intermediaries between savers and
investors

Within this conception of the monetary system, households initiate a process

whereby their initial savings are channelled to firms for productive investment
through the intermediation role of the banking sector. Jakab and Kumhof
(2015) present this intermediary view in an ironic way, saying that savers
deposit previously accumulated gravel in banks, which in turn lend the gravel
to entrepreneurs who wish to use it for productive purposes. As described
in Figure 5.1, this ensuing business investment generates an income flow, a
portion of which is held as savings. These savings then return to the banking
sector, by starting up a new process as a portion of these savings are accumu-
lated as bank deposits.
In their role as intermediaries between savers and investors, profit-maximiz-

ing banks make out loans to firms to finance their investment, which through
the saving process are once again deposited and re-channelled through the
banking sector to finance further loan expansion. This feedback process is
then propelled forward until the possibility of further loan making from
the initial injection of deposits has completely worked itself out. However,
the system depicted in Figure 5.1, in its essentials, is a supply-determined
system, whose growth is constrained by the reserves, say, of precious metals,
or in modern times by the initial reserves of central bank money that was
deposited in the banking system. Hence, for the system to expand, it requires
the supply of base money to increase, which then allows the banking sector
to serve its crucial allocative role of distributing loanable funds for produc-
tive investments. Moreover, whether this base money represents the stock of
commodity money or of central bank-issued money is of no theoretical sig-
nificance, since in either case it is the supply of these initial reserves, regard-
less of their precise forms, which moves the banking system forward in its
role as intermediary between savers and investors.
The heterodox perspective

The heterodox theory of money and banking stands this mainstream per-
spective on the nature and origin of money and the functioning of the
banking system somewhat on its head. The notion that money emerged from
barter does not find strong basis in anthropological history. Credit/debit
relations stipulated in a particular accounting unit (normally enforced by law
or custom) pre-date the appearance of organized market exchange. When
money did appear, mostly through the actions of the state, it took on the role
of means of payment for settling debt obligations, especially tax liabilities
(see Peacock, 2013). Within this perspective, and in contrast to the main-
stream view, the particular characteristic of the commodity chosen as the
unit of account was of little significance. What mattered was that money

was an abstract social unit, which was sanctioned by the legal apparatus of
the state, and which would then become the means to discharge liability in a
creditor–debtor relation. From this, it would ensue that money was not just
a particular commodity with some special characteristic feature to facilitate
exchange in the context of a natural, previously organized barter exchange
system. Instead, the heterodox view suggests that money, as a means of can-
celling debt, probably pre-dated organized market exchange itself. Emerging
through the expenditures of the state, the legally sanctioned currency enter-
ing circulation eventually would not only assume the role of a means of
payment in extinguishing debt obligations, but also the role of medium of
exchange, and an evolving store of liquidity within organized markets.
Money, in the sense conceived by heterodox writers, appears in organ-

ized markets not as a commodity having some special intrinsic attribute as
money. It appears, instead, as a third-party liability having only an extrinsic
social value as legal tender, bestowed on it through the legal apparatus of
the state either via its monopoly control over the central issuer of the cur-
rency (the mint) as during the Middle Ages, or through the state’s monetary
arm in modern times, namely its central bank (see Parguez and Seccareccia,
2000, p. 101). Banking institutions originated not primarily from some mis-
trustful group of profit-seeking goldsmiths who were lending out precious
metals while pretending to be holding them in their vaults for safekeeping.
Banking institutions existed even before the seventeenth century, and these
institutions were slowly becoming specialized in the business of finance
through double-entry bookkeeping, especially the financing of inventories
for long-distance trade, because of the trust that they inspired through the
public holding of their ‘I owe you’s’ (IOUs), often through the tacit or direct
support of the domestic authorities where they were based. In fact, already
in twelfth-century Venice and later, many early commercial banks, such as
the Sveriges Riksbank and the Bank of England in the seventeenth century,
actually began as government debt agencies that issued debt certificates or
promissory notes, which were then used by merchants and eventually the
public as means of payment. However, by the eighteenth and nineteenth cen-
turies, banks typically acquired from the government authorities a charter,
which was a certificate or license authorizing the operation of a bank, whose
business involved that of making loans and collecting deposits. Also, during
that era, the bank charter normally gave the private institution the right to
circulate its own privately issued bank notes denominated in the currency
units established by the state. Because of their convenience, these private
bank notes came to compete with the coins produced by the mint, until
the mid-nineteenth century, when chequing facilities permitted chequable
deposits to become more important than private bank notes in circulation.

However, because of public distrust in the viability of a payments system

that can easily succumb to bank failures, at around the same time during the
nineteenth century, governments started to assert monopoly control over the
issue of paper currency notes so that, by the twentieth century, private bank
notes virtually disappeared from circulation in Western countries.
With the decline of primary/agricultural activities and the rise of modern

industrial production, banks extended their activities from the financing of
inventories to that of financing short-term circulating capital requirements
to facilitate the process of production itself. By the nineteenth century, bank
credit played a central role in the financing of industrial production. Because
of the fears of short-term withdrawals of bank deposits, banks were expected
to behave prudently by financing the short-term circulating capital require-
ments of business enterprises in accordance with the ‘real bills’ doctrine.1
Bank credit was not to be channelled towards the long-term funding of fixed
capital investment, which instead ought to rely on business retained earnings
or, through the issuing of securities with the deepening of financial markets,
by capturing household saving.
To understand the traditional role of banks within this heterodox approach,

let us begin with the fact that much like the state liability issued by central
banks, the private banking sector as a whole could create credit-money at
the stroke of a pen or ex nihilo (which is the Latin expression for ‘out of
nothing’). This is because, contrary to the mainstream tale of goldsmith
banking, banks as a whole, and as long as they move closely in tandem in
their lending, are not constrained by the amount of reserves arising from
their deposit-taking activity. Within this perspective, it is actually loans that
make deposits. Indeed, as soon as a bank makes out a loan to a creditworthy
borrower, through double-entry bookkeeping, there will appear a counter-
party deposit, which will initially appear in the private borrower’s account
(or in the case of an online credit this would happen instantly), which is then
used to carry out the borrower’s spending need. If the borrower were a firm,
this credit money would go towards the compensation of workers and/or the
purchasing of material inputs for the production process. In the archetypal
version of bank financing production, this credit gives rise to a circulatory
process, as shown in Figure 5.2.
Unlike the tale of goldsmith banking, this process of money creation is not
driven by some initial deposits entering the banking sector. If such were the
case, then where would the deposit first come from, unless it comes from
some outside source, such as a government? Within the private banking
sector, deposits can only appear when loans are made to either businesses

Monetary Reflux Expenditure Flow
FIRMS HOUSEHOLDS
BANKS
Monetary Flow Income Flow
Bank Deposits
Figure 5.2 The heterodox conception of banks as creators of credit money within the
framework of a rudimentary monetary circuit
or households. Instead, the initial injection of credit money created ex nihilo

is sometimes described as the initial finance. The ‘monetary flow’ arrow
in Figure 5.2 represents these initial credit advances to firms, which gener-
ate an ‘income flow’. Households, on the receiving end of this income flow,
would have a choice to allocate their income towards consumption or saving.
In a world with no household saving, all the income is spent, which then
allows firms to capture all of this income generated by the initial bank credit
advances (as shown in the ‘expenditure flow’ arrow), thereby permitting
firms to extinguish their debts vis-à-vis the banking sector.
In a world (say, of the nineteenth century) with non-existent (or very

shallow) financial markets, the only possible saving is represented in
Figure 5.2 in its most unsophisticated form of holdings of bank deposits.
This is shown by the return arrow from the household sector to the banks
(unless one also considers the option of hoarding bank notes under the mat-
tress or in the cookie jar). As can be seen in Figure 5.2, with the leakage into
bank deposits from the household sector, this withholding of consumption
spending in liquid form as bank deposits, representing household liquidity
preference, can short-circuit the flux/reflux process and prevent the busi-
ness sector from extinguishing its overall debt to the banks. With a certain
portion of the income flow not being spent, this would thrust banks into
an uncomfortable intermediary role of ‘deposits making loans’. Hence, it is
only in this crisis state of incomplete closure of the monetary circuit, with
household saving held in its most liquid form, that the causality between
loans and deposits is reversed, since the desire to hold liquid deposits de
facto forces banks to try to re-extend loans that cannot be fully reimbursed
via the reflux. However, this is hardly the most realistic scenario, as shown in
Figure 5.3, when there exist organized financial markets, reflecting a histori-
cally more sophisticated phase of financial deepening with a greater variety
of portfolio choice.

Indeed, in the heterodox literature, there is an important distinction that is

made between the ‘initial’ finance of the process of monetary and income
expansion and the ‘final’ finance, which is associated with the reflux phase
of this balance sheet circulatory process (see Graziani, 2003). In Figure 5.2,
we have only considered the most elementary case, where the monetary flow
from the banking sector gives rise to an equivalent monetary reflux through
the consumption expenditures of households, unless households choose to
hold savings in the most liquid form of cash or bank deposits, in which case
the latter holdings can short-circuit the process.
Let us now consider a world of financial deepening represented in Figure 5.3.

Households can now choose a whole portfolio of financial assets issued
directly by firms, such as corporate stocks or bonds, or other forms of finan-
cial instruments offered by investment banks, or even through the inter-
vention of non-bank financial intermediaries. These liabilities may not be
considered good substitutes for commercial bank deposits and thus are not
normally acceptable as means of payments. This broad spectrum of institu-
tions constituting the financial markets is depicted in Figure 5.3 as a separate
space into which household saving flows out of household income and these
institutions do engage in financial intermediation. However, this interme-
diation is not between savers and investors, as it is normally described by
the mainstream theory of loanable funds, because investment, or the new
production and accumulation of capital goods, has already occurred. After
production has taken place, what the financial markets do during the reflux
phase is to bring together households which have chosen to save in the form
of less liquid assets, and firms in search of long-term or ‘final’ finance, in
order to allow the latter to extinguish their ‘initial’ short-term debts vis-à-
Monetary Reflux Expenditure Flow
FIRMS HOUSEHOLDS
BANKS
Monetary Flow Income Flow
FINANCIAL
MARKETS
Bank Deposits
Figure 5.3 The heterodox conception of banks as creators of credit money with organized
financial markets

vis the banking sector. This is described by the arrows going from house-
holds choosing to save a portion of their incomes being channelled into the
financial markets, and firms simultaneously accessing these savings for final
finance.
There are numerous complications to this heterodox macroeconomic analy-

sis of banks as creators of credit-money that can be added to offer a greater
degree of realism. For instance, we can include in the monetary reflux not
only the principal of the loan made out to firms that must be reimbursed, but
also an analysis of the interest rate spreads from which banks traditionally
make profit. In addition, one can also consider the case where households
enter into debt vis-à-vis the banking sector to obtain consumer loans or take
out mortgages. Also, from the portrait just described of the relation between
banks and firms, on the one hand, and firms and households and the finan-
cial markets on the other hand, we have excluded the role of the government
and the central bank. However, these are complications that can and have
been analysed by heterodox economists. In order to provide the reader with
a more comprehensive understanding of the mechanics of this fundamental
relation between banks and the private sector, by considering the case of a
consumer loan, but also between commercial banks and the central bank
and payments system, let us now describe briefly this process from the stand-
point of banks’ balance sheets.
Understanding the heterodox approach to banks and

the modern payments system from a simple balance
sheet perspective
Most mainstream textbooks treat money just as they would treat commodi-
ties: they assume that money should be scarce for it to keep its value, as if
money were akin to gold, and they assume that it is the role of the central
bank to make sure that this is so. If there is too much money or if the stock
of money grows too fast, according to the mainstream story, there will be an
increase in the general price level and the exchange rate of the domestic cur-
rency relative to other currencies will depreciate.
We have seen that mainstream economists assume the existence of a money

creation mechanism based on the so-called money multiplier process and
fractional-reserve banking system. They assume that in order to be able to
grant loans and issue money, commercial banks must first acquire a special
kind of money – reserves at the central bank – because financial regulations
in a number of countries require banks to hold a certain fraction of the money
deposits of their customers in the form of a specific kind of assets, namely,

reserves at the central bank. According to this story, deposits of agents at

banks are thus a multiple of these reserves, roughly speaking the inverse of
this required percentage; say, a multiplier of 20, if the required percentage of
reserves to bank deposits is 5 per cent. By controlling the amount of reserves
that commercial banks have access to, it is said that the central bank has the
ability to control the supply of money in the whole economy.
The causality of this mainstream story is thus the following: depending on its
objectives, mainly concerned with a stable aggregate price level, the central
bank creates a certain amount of reserves. This then allows the creation of a
multiple amount of loans and deposits, the latter with the addition of bank-
notes, constituting the supply of money, which hopefully is in line with the
needs of the economy.
There are however countries where there are no reserve requirements; this
obviously makes the mainstream story rather questionable if not meaningless.
The creation of money must follow some other mechanism. It is the purpose
of the following subsections to examine this more realistic mechanism.
Transactions of the private sector

As we have seen from our analysis of the monetary circuit, the process of
money creation is simple yet fascinating. Money creation – the creation of
bank deposits – relies on three key elements: the willingness of banks to take
risks and grant loans, the creditworthiness of borrowers, and the willingness
of borrowers to go into debt and take a loan. No more is required. Banks do
not need to hold gold and neither do they need to hold reserves at the central
bank. Money is created ex nihilo.
Suppose that an individual wishes to buy a new car worth $30 000 and needs
to borrow to do so. This person will need to show that they are creditworthy,
for instance, by showing that they have a regular income, that this income is
likely to be large enough to make the monthly payments, and that interest
and principal have been paid on previous loans (that is, the person has a good
credit record).
What happens next? As pointed out in our previous discussion, the loan
is created at the stroke of a pen, or rather by punching a couple of keys on
the banker’s computer. As the bank grants the loan, there is a simultaneous
creation of a bank deposit: money gets created. This is shown in Table 5.1,
which shows the changes in the balance sheet (the T-account) of the bank
of the borrower: the bank now has $30 000 more in loans on the assets side

Table 5.1 Changes in the balance sheet of a bank that grants a new loan
Bank of the car purchaser
Assets Liabilities
Loan to car purchaser +$30 000 Deposit of car purchaser +$30 000
Table 5.2 Changes in bank balance sheets after the payment is made
Bank of car purchaser Bank of car dealer
Assets Liabilities Assets Liabilities
Loan to car purchaser Debit position at Credit position at Deposit of car dealer
+$30 000 clearinghouse clearinghouse +$30 000
+$30 000 +$30 000
of its balance sheet, but simultaneously, on the liabilities side, there is an

increase of $30 000 in bank deposits. The car purchaser now has a bank debt
of $30 000, which from the standpoint of the bank is an asset, but at the same
time the bank now owes a $30 000 deposit to the car purchaser. This is why it
is on the liabilities side of the bank’s balance sheet.
What then happens next? The individual obtained a car loan because they
wanted to buy a car. So the purchaser goes to the car dealer, most likely with a
certified cheque, and once all papers are signed, drives off with the car, while
the car dealer rushes to deposit the cheque in their bank account. Once this
is done and the cheque goes through the payments system, the new balance
sheets are shown in Table 5.2.
All banks are members of a payments and settlement system, either directly,
or indirectly in the case of small banks that use the account of a larger bank.
Indeed, their participation in the payments system is one of the key services
rendered by banks. As payments go through banks, bank deposits move from
one account to another. These payments are centralized at a clearinghouse,
which keeps the tabs, so to speak. As the cheque (in paper form or elec-
tronic form) clears the payments system and goes through the clearinghouse,
the $30 000 are taken away from the car purchaser and end up in the bank
account of the car dealer. However, now the bank of the car purchaser owes
$30 000 dollars to the clearinghouse, while the clearinghouse owes $30 000
to the bank of the car dealer, which is what Table 5.2 illustrates.

Table 5.3 Changes in bank balance sheets when banks lend to each other
Loan to car purchaser Loan taken from Loan to bank of car Deposit of car dealer
+$30 000 bank of car retailer purchaser +$30 000 +$30 000
+$30 000
In all payments systems, amounts due between participating financial insti-

tutions must be settled at least by the end of the day. How this will be done
depends on the institutional set-up, which is specific to each country. In
the simplest case, the bank that is in a credit position at the clearinghouse
– the bank of the car dealer – will grant what is called an overnight loan (at
the overnight rate of interest) to the bank that is in a debit position at the
clearinghouse – the bank of the car purchaser. This is the overnight market,
also called the interbank market, since it involves banks and a few large finan-
cial institutions. Banks will lend to each other as long as participants to the
payments system have confidence in each other. Table 5.3 illustrates this
situation.
As was the case with the loan to an individual, we see that the banking system
relies on trust and creditworthiness. Banks must have sufficient confidence
in other banks. When banks start lacking trust, the overnight market so
described, where banks in a daily surplus position at the clearinghouse lend
funds to banks that are in a negative position, will freeze and banks will
decline to lend to each other. This happened in Europe in August 2007, when
all financial institutions were scared to make overnight loans to German
banks, because of the failure of two German banks. Fears spread to the rest of
the world and overnight markets lost their fluidity elsewhere as well, as banks
became reluctant to lend large amounts to each other.
What then happens if the overnight market does not function properly or if,
for some reason, a bank in a negative position at the clearinghouse cannot
get an overnight loan from some other bank? Does the payment made to the
car dealer still go through? It will, and this is where the central bank plays its
role of lender of last resort. In this case, using again the two banks described
in Tables 5.1 and 5.2, the central bank makes an overnight loan to the bank of
the car purchaser, thus allowing it to settle its position at the clearinghouse,
as shown in Table 5.4. And what happens to the bank of the car dealer? If it
declines to lend its surpluses at the clearinghouse, it has no other choice than
to deposit its surpluses in its account at the central bank. The deposits of

Table 5.4 Changes in the balance sheet of banks and the central bank when banks decline
to lend to each other
Loan to car purchaser Loan taken from the Deposit at the Deposit of car dealer
+$30 000 central bank +$30 000 central bank +$30 000
+$30 000
Central bank
Assets Liabilities
Advance to the bank of car purchaser Deposit of the bank of car dealer +$30 000
+$30 000
the bank of the dealer at the central bank are what mainstream authors call
reserves; central bankers now refer instead to clearing balances or settlement
balances. Table 5.4 also illustrates the fact that the size of the balance sheet
of the central bank will balloon any time overnight markets do not function
properly.
As noted previously, there are many possible set-ups for payments and set-
tlement systems. In the set-up assumed so far, unless the overnight market
collapses, all the activity occurs in the clearinghouse, which can be run by a
private entity, owned by the bankers’ association for instance. Another pos-
sible set-up, often assumed in textbooks and actually existing in several coun-
tries, is that clearing and settlement occurs on the books of the central bank.
In that case, payments can only go through, and hence settlement occurs, if
the bank making the payment – here the bank of the car purchaser – already
has deposits at the central bank (if it has reserves). Table 5.5 illustrates this
situation: the bank of the car purchaser sees its reserves at the central bank
diminished by $30 000, while those of the bank of the car dealer get aug-
mented by the same amount.
When an individual bank starts to run out of reserves, it will have to borrow
funds on the overnight market, thus borrowing the funds from banks that
have a surplus of reserves (this is the federal funds market in the United
States); or it might borrow the reserves from the central bank, as illustrated
in Table 5.4. Thus the role of the central bank is not to put limits on the
creation of reserves; its role is purely defensive: it needs to provide enough

Table 5.5 Changes in balance sheets when the central bank acts as the clearinghouse
Loan to car purchaser Reserves at the Deposit of car dealer

+$30 000 central bank +$30 000
Reserves at central +$30 000
bank −$30 000
Central bank
Assets Liabilities
Deposit (reserves) of the bank of car dealer +$30 000

Deposit (reserves) of the bank of car purchaser −$30 000
reserves to ensure that the payments system runs smoothly. In countries

where the clearing occurs essentially through the clearinghouse, and where
payments are netted out at the end of the day, there is no need for reserves,
and hence, unless some regulation imposes required reserves as a fraction of
some measure of assets or liabilities, there will be zero reserves, as is the case
of Canada, for instance. By contrast, in countries where the clearing occurs
through the central bank and where payments are settled in real time as they
go through, banks will have to hold reserves at the central bank, which will
then act as the clearinghouse, ensuring that there are enough clearing or
settlement balances to absorb the fluctuations in incoming and outgoing
payments.
Transactions of the public sector

What should be noted is that the total amount of clearing balances (or
reserves) in the banking system is a given as long as all transactions occur
between private agents. As is obvious from Table 5.5, any increase in the
reserves of one bank will be compensated by the decrease in the deposits of
another bank. Thus the overall amount of reserves in the banking system can
only be changed if a transaction occurs with the public sector, that is, when
the central bank is involved in one of the transactions. Such a transaction is
in fact already described by Table 5.4. In this case, the central bank provides
an advance to the banking sector, thus generating the creation of an equiva-
lent amount of reserves for the banking system. More generally, if the central
bank feels that there is a higher demand for reserves by the banking sector,

Table 5.6 An open-market operation when the central bank wishes to increase the amount
of reserves or to compensate for a previous fall in reserves
Commercial bank Central bank
Treasury bills −$10 000 Treasury bills Deposit of commercial

Reserves at central bank +$10 000 bank +$10 000
+$10 000
additional reserves can be created by making advances to some banks, for

one night, one week, one month, or perhaps even three years as was done by
the European Central Bank at the height of the euro area crisis in 2011.
However, there are other ways in which reserves are created (or destroyed).
As reflected in mainstream textbooks, reserves are created whenever the
central bank purchases assets from the private sector. Table 5.6 provides such
an example. It is assumed that the central bank purchases a government secu-
rity from the banking sector; for instance, a Treasury bill that had been issued
earlier by the government and bought by a bank. This transaction, whether
it is outright or whether the central bank promises to sell it back within a
period of time (in which case it is a repurchase agreement, a repo), leads to
the creation of new reserves for the banking sector. This type of transaction
is called an open-market operation. Of course, it can go the other way; for
instance, when the central bank sells the Treasury bills that it holds to the
private sector, in which case reserves are destroyed.
The central bank is usually the fiscal agent of the government. This means
that the central bank is empowered with the responsibility of selling the secu-
rities that the government issues when it borrows funds; it also means that
the central bank manages the cash balances of the government and, in par-
ticular, it implies that the government has an account at the central bank.
Consequently, any time there is an outgoing or incoming payment involving
the government deposit account at the central bank, there will be a creation
or a destruction of reserves (Box 5.1). Central bankers call these the ‘autono-
mous factors’ that affect the amount of reserves in the banking system.
Take the example of a civil servant receiving their monthly pay, assuming that
it comes out of the account of the government at the central bank. Table 5.7
illustrates this case: the bank account of the civil servant will now increase
by $5000. As the payment goes through the clearinghouse, and is settled, the

Box 5.1
WHERE DO GOVERNMENT DEPOSITS COME FROM?

In Table 5.7, we assumed that the govern- with a negative position at the clearing-
ment had deposits at the central bank, house or with a loss of reserves; the central
thus allowing it to pay its civil servants. bank must either provide advances to the
However, where do these deposits come banking sector or purchase back the securi-
from? Several answers are possible. First, ties on secondary markets, if it wants to
the central bank could make a loan to the keep the overnight interest rate at its target
government, just as a bank provides loans level. It would then have been simpler for
to producing firms, but this is universally the central bank to go with the second pos-
forbidden today. Second, the government sibility and buy the securities right away (on
could issue securities, purchased entirely the primary market). A fourth possibility is
or in part by the central bank, with the when taxes are being paid by households
government thus acquiring deposits at the and firms, as these payments feed the
central bank; besides Canada, few coun- deposit account of the government at the
tries, however, proceed in this manner. A central bank. It should be noted, however,
third possibility is for the government to that if the incoming taxes are greater than
issue securities, purchased (on the primary government expenditures, the banking
market) by banks or bond dealers: this sector overall will again be in a negative
is the standard procedure. The proceeds position at the clearinghouse, and will need
of the sale are then brought back to the to be provided with advances by the central
deposit account of the government at the bank.
central bank. In this case, banks wind up
Table 5.7 Changes in balance sheets induced by government expenditure
Commercial bank Central bank
Reserves at central Deposit of civil Deposit of government −$5000

bank +$5000 servant +$5000 Deposit of commercial bank +$5000
government deposits at the central bank decline by $5000, while the reserves
of the bank of the civil servant increase by $5000. Thus, when the govern-
ment makes a payment to the private sector, through its account at the central
bank, this creates reserves. Things go in reverse gear if the civil servant has to
pay their income taxes; say, at the rate of 40 per cent. The deposits of the civil
servant will fall by $2000 and, if the proceeds are deposited in the account of
the government at the central bank, the reserves of the banking system will
be reduced by $2000 (Wray, 2012, Ch. 3).

Box 5.2
ARE THERE LIMITS TO CREDIT CREATION?

If bank reserves (the amount of their depos- thus cause trouble, either because the entire
its at the central bank) are not a constraint equity is wiped out (in which case the bank
on money and credit creation, as argued becomes insolvent and would need to be
in the chapter, is there another supply closed down) or simply because the remain-
constraint? A number of economists, ortho- ing loan book value exceeds the allowed
dox and heterodox alike, believe that the multiple over bank equity. In the latter case,
equity of a bank (its own funds: the capital the bank will be restrained in making new
of its owners) provides such a constraint. loans. However, in general, a bank which
This is based on the notion that regula- is on the edge of the BIS regulation can
tions devised by the Bank for International always make more loans if it wishes to do
Settlements (BIS) are such that bank loans so: it suffices to accumulate a portion of its
can only be a certain multiple of bank profits in the form of retained earnings or
equity. When a loan defaults, the bank to sell new shares, to increase the size of its
equity is reduced by the size of the default- equity.
ing loss. Large losses on previous loans may
The lesson to be drawn here is that commercial banks are the institutions
that grant loans and create money ex nihilo. There is no constraint on how
much can be created, with one exception. A banker must keep the trust and
confidence of depositors and of fellow bankers, and so must make sure that
the number of ‘non-performing loans’ – loans on which borrowers default,
thus creating losses for the bank – is minimized, to avoid the arising of sus-
picion. Commercial banks do not need central bank reserves to grant loans.
On the contrary, the role of the central bank is to make sure that there is the
right amount of reserves in the banking system, to ensure that the payments
system is running smoothly. The central bank will react to changes in the
‘autonomous factors’ affecting reserves, which we discussed above either by
pursuing open-market operations or by providing advances to the banking
sector. To sum up, we may say that the supply of money is endogenous,
responding to the demand of the economy, and that the supply of reserves is
also endogenous, responding to the needs of the payments system (Box 5.2).
Concluding remarks
The heterodox view of money and banking stands on its head much of
the mainstream theorizing on the role of money and banks that still reign
supreme in popular textbooks. Money is not a commodity that is dropped

exogenously from a helicopter to render more efficient the exchange of

commodities and services. Money is a means of payment that permeates
social relations and permits economic agents in a community to free them-
selves from the constraints of scarcity that a barter economy imposes. Money
is not some predetermined object but, in its essence, an endogenous crea-
tion that is issued by institutions established or licensed by the state. This
money emerges through a balance sheet operation associated with changes
in a third-party liability, whether it is the state through its central bank liabil-
ity, or through the strategic role played by banks via credit-money creation
reflected in changes in their deposit liabilities. As long as there are credit-
worthy borrowers, credit-money creation is demand-driven. It can never be
supply-constrained as claimed by the mainstream. Moreover, because banks
are not reserve-constrained as a group and money creation is an outcome of
the interaction between an individual borrower and a bank, money cannot
be an exogenous variable as normally depicted in the textbooks. Indeed, bank
credit follows a circular process of money creation and money destruction
and, therefore, in contrast to the mainstream, which emphasizes its role in
facilitating exchange, the most crucial social feature of money is associated
with its financing of production, where commercial banks have played a
central role since the nineteenth century.
NOTE
1 The ‘real bills’ doctrine rested on the belief that prudent banking practices required that commercial banks
engage only in short-term lending, in the sense that banks would discount commercial bills or promissory
notes on the basis of collateral representing ‘real’ goods engaged in the production process. This essentially
meant that commercial banks should passively accommodate the ‘needs of trade’ by financing the short-
term circulating capital requirement, such as the wage bill, and not finance the purchases of fixed capital
assets. For further discussion, see Humphrey (1982).
REFERENCES
Graziani, A. (2003), The Monetary Theory of Production, Cambridge, UK: Cambridge University
Press.
Humphrey, T.M. (1982), ‘The real bills doctrine’, Federal Reserve Bank of Richmond Economic
Review, 68 (5), 3–13.
Jakab, Z. and M. Kumhof (2015), ‘Banks are not intermediaries of loanable funds – and why this
matters’, Bank of England Working Paper, No. 529.
Parguez, A. (1975), Monnaie et macroéconomie: théorie de la monnaie en déséquilibre, Paris:
Economica.
Parguez, A. and M. Seccareccia (2000), ‘The credit theory of money: the monetary circuit
approach’, in J. Smithin (ed.), What is Money?, London, UK and New York, USA: Routledge,
pp. 101–23.
Peacock, M. (2013), Introducing Money, London, UK and New York, USA: Routledge.
Realfonzo, R. (1998), Money and Banking: Theory and Debate (1900–1940), Cheltenham, UK and
Northampton, MA, USA: Edward Elgar Publishing.

Rochon, L.-P. and M. Seccareccia (eds) (2013), Monetary Economies of Production: Banking and
Financial Circuits and the Role of the State, Cheltenham, UK, and Northampton, MA, USA:
Edward Elgar Publishing.
Smith, A. (1776/1937), An Inquiry into the Nature and Causes of the Wealth of Nations, New York:
Modern Library.
Wray, L.R. (2012), Modern Money Theory: A Primer on Macroeconomics for Sovereign Monetary
Systems, Basingstoke, UK and New York, USA: Palgrave Macmillan.

A PORTRAIT OF ALAIN PARGUEZ (1940–)

Alain Parguez is Professor Emeritus at the limits to the creation of money, because the
Université de Franche-Comté, Besançon, latter can be created ex nihilo. Therefore,
France. Together with the late Augusto the building of models of modern econo-
Graziani, Parguez has been a leading figure mies where banks are mere intermediaries
of what has been sometimes described his- whose loan advances depend either on past
torically as the Franco-Italian Circuit School. savings or on the amount of base money
His ideas are deeply rooted in the works of created by the central bank, rather than
French Keynesian economists of the post- being conceived as creators and destroyers
war period, the most noteworthy being Jean of money, can lead to catastrophic policy
de Largentaye and Alain Barrère. However, consequences. An example of this mis-
his writings find inspiration in the macro- guided policy, based on such erroneous
economic and monetary views of Karl Marx, theories of commercial banking, is the
John Maynard Keynes, Michał Kalecki and attempt to kick-start economic growth since
Joan Robinson, as well as the monetary ideas the 2007–08 financial crisis through the
of such heterodox writings going back to the policy of quantitative easing. This led to an
Banking School in the nineteenth century. explosion of reserves in the banking system,
His ideas on money and the role of banks but without significant effects on economic
in the monetary circuit were first espoused growth, with the possible exception of sus-
in an important book titled Monnaie et taining asset prices by keeping the level of
macroéconomie: théorie de la monnaie interest rates at their lower bound.
en déséquilibre (1975). These ideas on the In a similar fashion, Parguez has been a
monetary circuit were further developed staunch critic of the institutional structure
in a series of publications that followed his of the euro area because of the formal sev-
book, particularly in the two French jour- ering of any direct link between monetary
nals Économie appliquée and Économies creation through a supranational central
et sociétés, where, in the case of the latter, bank (the European Central Bank) and the
he had edited a special series Monnaie actions of the national fiscal authorities.
et Production that lasted from 1984 to He has argued that the original architects
1996. More recently, a book came out in of the euro tried to create a monetary
his honour titled Monetary Economies of system not unlike that founded on gold,
Production: Banking and Financial Circuits going back to the nineteenth century, with
and the Role of the State (Rochon and results that have been just as catastrophic.
Seccareccia, 2013), which celebrates his Although Alain Parguez has been an ardent
contributions to political economy. supporter and advocate of the monetary
According to Alain Parguez, the main- circuit approach, over the years he has done
stream views on money and banking lead to much to promote exchanges with other
a world of institutionalized scarcity, because heterodox theorists of money within the
they start from the misleading premise that broad post-Keynesian tradition, for instance
money should be a scarce commodity and with economists such as Paul Davidson and
that banks are mere intermediaries between Basil Moore, as well as with writers associ-
savers and investors. In contrast to the main- ated with Modern Monetary Theory (MMT),
stream austerity perspective, Parguez starts such as Warren Mosler and L. Randall Wray.
from the view that there are no supply-side

? EXAM QUESTIONS
True or false questions

1. The heterodox theory of money rejects the view that money should be considered merely a
special type of commodity invented for the primary purpose of facilitating exchange. Money
is the result of a balance sheet operation resulting from the appearance of a third-party liabil-
ity of either a private commercial bank or a central bank.
2. Money creation arises when the central bank prints more money from which a multiple
expansion of deposits can take place within the banking system. Hence, money is supply-
determined and the only limit to the money supply expansion is the amount of reserves held
by the banks and the amount of cash held by the public.
3. In their essential role, banks are storehouses of money or mere financial intermediaries spe-
cialized in deposit taking upon which they can then fund creditworthy borrowers desiring to
invest within an organized market for loanable funds.
4. The distinction between initial finance and final finance is crucial to understanding the
process of monetary circulation. The first (initial finance) describes the creation or injection
of money through bank loans as this new money generates income flows, while the latter
(final finance) describes the reflux side or the monetary destruction as the borrowing unit
reimburses its debt.
5. Liquidity preference is the withholding of private spending in liquid form as bank deposits.
The accumulation of bank deposits can ‘short-circuit’ the flux/reflux mechanism and prevent
the business sector from reducing the initial bank debt.
6. The own funds of the bank (or its paid-up capital) should appear on the asset side of the
balance sheet of a bank.
7. Tax revenues are a prerequisite to public spending.
8. Within the mainstream view, the role of the central bank is primarily to prevent the excessive
expansion of the money supply by setting a floor on the holding of bank reserves. In contrast,
heterodox economists emphasize the lender of last resort or accommodative function of the
central bank in supplying reserves for the proper functioning of the payments system.
9. When the government spends more than it receives in tax revenues within a given period,
thereby running a budget deficit, the rate of interest on the overnight market for funds goes
up, in which case the central bank must remove reserves from the banking system.
10. In a modern monetary system, while a single commercial bank can be reserved-constrained,
the private banking sector, as a whole, can never be, unless affected by the autonomous actions
of the government in reducing the amount of overall reserves in the system.
Multiple choice questions

1. What seems truer about the origins of money?
a) In a barter economy in which individual exchangers benefit from the division of labour,
money was invented as medium to minimize transactions costs relating to the exchange of
goods and services in a market context.
b) Since money is an abstract unit of account, only in a modern advanced economy where
there already exists a sophisticated division of labour could money actually have appeared.
c) With the increasing division of labour and specialization, money emerges from the
expanded use of precious metals technologically, such as gold and silver, because of these
commodities’ special characteristics of divisibility, portability, durability, fungibility and
their scarcity.

d) Money emerged historically as a means of payment, in its capacity to extinguish debt

obligations, of which the most important was tax liabilities to the state, regardless of the
degree of sophistication of the division of labour in that economy.
2. Heterodox economists flip the theory of the so-called ‘money multiplier’ on its head, in which
exogenous changes in base money trigger a multiple expansion of the money stock in an
economy, because:
a) they interpret the causality in reverse to that of the traditional interpretation that is based
on a supply-side view of bank lending behaviour;
b) base money is no longer composed of precious metals;
c) banks do not normally try to seek to extract greater profits when seeking to expand loans
on the basis of the increased base money;
d) banks can only lend their excess reserves.
3. What happens to the bank equity if the bank suffers from a bad loan worth $10 billion?
a) The liability side shrinks by $10 billion.
b) The asset side shrinks by $10 billion.
c) Both the asset side and the liability side shrink by $10 billion.
d) Both the asset side and the liability side increase by $10 billion.
4. In the circulatory process that is connected with the process of monetary creation and
destruction in a modern economy, which was described as a monetary circuit, identify which
of the following actions pertain to the monetary ‘reflux’ associated with an eventual destruc-
tion of money:
a) the issuing of a bank loan to pay wages and salaries by a firm;
b) the regular payment of interest by households on a bank loan;
c) the weekly grocery purchases by a household;
d) the purchase of an already existing corporate bond by an individual through a brokerage
firm.
5. The dictum that ‘loans make deposits’ can be described as representing the normal
functioning of the banking system, because banks are not reserved constrained collectively.
However, we have suggested at least one exception when ‘deposits make loans’. What is this
exception?
a) This exception arises during times of crisis when the public is not sufficiently creditwor-
thy and, therefore, risk-averse bankers will make loans only if they have first secured an
equivalent amount of deposits.
b) During times of strong liquidity preference reflected in the build-up of an inordinate
amount of liquid deposits in the banking system, this could force commercial banks into
an uncomfortable position of extending loans to prevent business insolvencies and to cut
bank losses.
c) In reality, the dictum is wrong, since banks would not normally want to leverage them-
selves by issuing loans without the backing of deposits. The saying that ‘loans makes
deposits’ is actually the exception and not the norm.
d) The exception arises when banks lose trust and cease to lend excess reserves among them-
selves in the overnight interbank market for funds.
6. What happens to the balance sheet of the bank and that of the central bank when the govern-
ment issues new securities that are purchased by banks, with the proceeds of the sale being
kept by the government as deposits in the banks?
a) Banks have a bigger balance sheet and so does the central bank.
b) Banks have more bonds on their liability side.
c) Banks have more bonds on their asset side.
d) Banks have more reserves at the central bank.

7. As happened during the global financial crisis, many commercial banks facing a negative posi-
tion in the clearing system were unable to obtain an overnight loan from other banks which
found themselves in a surplus position because of the fear of bank insolvencies. What could
banks mostly likely do if they find themselves in a negative position?
a) They could pretend that nothing has happened and announce that their books are bal-
anced in the hope that the bank supervisory authorities do not recognize their balance
sheet problem.
b) They could sell some of their assets to the public.
c) The could declare bankruptcy and merge with banks in a positive settlement position.
d) They could borrow directly at the discount window of the central bank.
8. It has been shown that, while the total reserves within the banking sector remain unaffected
by the volume of transactions within the private sector, the overall amount of reserves in the
banking system adjusts only when transactions are with the public sector. In particular, total
bank reserves go up:
a) when the central government cuts various taxes and service charges, without cutting pro-
portionally its overall spending;
b) when the central bank buys government securities in the financial markets as occurred
under quantitative easing (QE) interventions;
c) when the government transfers some of its deposits from its account at the central bank to
a commercial bank;
d) if any of the above occur.
9. What happens to the balance sheets of the banks and of the central bank when households
pay their income taxes by drawing on their bank deposits?
a) Deposits of households at banks go up, but the deposits of banks at the central bank go
down.
b) Deposits of households at banks go down, but the deposits of banks at the central bank go
up.
c) Both the deposits of households at banks and those of banks at the central bank go down.
d) Both the deposits of households at banks and those of banks at the central bank go up.
10. Following the global financial crisis of 2007–08, a number of central banks implemented a
policy of quantitative easing (QE) to encourage bank lending and re-establish private spend-
ing by flooding the banking sector with excess reserves.
a) The effect was to reduce interest rates dramatically and stabilize asset prices, thereby
leading to high economic growth.
b) The effect was to bring down the interest rate on the overnight interbank funds market to
its lowest possible level, but its effect on bank lending and economic growth was marginal.
c) The massive rise in bank reserves directly stimulated bank lending and, therefore, pre-
vented a drop in private spending.
d) Since fiscal policy was seen as an ineffective tool and counterproductive because it would
push interest rates up, policy-makers had no other choice but to opt for QE to stimulate
private spending.

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Money and banking

• presents the heterodox approach to money and banking and contrasts

• explains why mainstream economists view money as a commodity that

• focuses on the importance of the creation and destruction of money

Readers will thereby understand why money is not a scarce commodity

M4921-ROCHON & ROSSI (2nd edn)_Text.indd 151 25/02/2021 08:09

• Commercial banking: Financial institutions engaged in the business of

Why are these topics important?

The traditional mainstream view

M4921-ROCHON & ROSSI (2nd edn)_Text.indd 152 25/02/2021 08:09

Hence, just as individuals at some moment in human history came to recog-

As this tale of money emerging from barter exchange is normally told in

This traditional perspective, therefore, rests on a particularly antiquated

Historically, while quasi-banking-related activities of advancing simple credit

M4921-ROCHON & ROSSI (2nd edn)_Text.indd 153 25/02/2021 08:09

goldsmiths, especially in seventeenth-century England. Banks appear in this

Banks appear as intermediaries in collecting a community’s accumulated

M4921-ROCHON & ROSSI (2nd edn)_Text.indd 154 25/02/2021 08:09

deposited for safekeeping. Moreover, whether individuals held bank deposits

M4921-ROCHON & ROSSI (2nd edn)_Text.indd 155 25/02/2021 08:09

Within this conception of the monetary system, households initiate a process

In their role as intermediaries between savers and investors, profit-maximiz-

The heterodox perspective

M4921-ROCHON & ROSSI (2nd edn)_Text.indd 156 25/02/2021 08:09

Money, in the sense conceived by heterodox writers, appears in organ-

M4921-ROCHON & ROSSI (2nd edn)_Text.indd 157 25/02/2021 08:09

However, because of public distrust in the viability of a payments system

With the decline of primary/agricultural activities and the rise of modern

To understand the traditional role of banks within this heterodox approach,

M4921-ROCHON & ROSSI (2nd edn)_Text.indd 158 25/02/2021 08:09

Monetary Reflux Expenditure Flow

Monetary Flow Income Flow

or households. Instead, the initial injection of credit money created ex nihilo

In a world (say, of the nineteenth century) with non-existent (or very

M4921-ROCHON & ROSSI (2nd edn)_Text.indd 159 25/02/2021 08:09

Indeed, in the heterodox literature, there is an important distinction that is

Let us now consider a world of financial deepening represented in Figure 5.3.

Monetary Reflux Expenditure Flow

Monetary Flow Income Flow

M4921-ROCHON & ROSSI (2nd edn)_Text.indd 160 25/02/2021 08:09

There are numerous complications to this heterodox macroeconomic analy-

Understanding the heterodox approach to banks and

We have seen that mainstream economists assume the existence of a money

M4921-ROCHON & ROSSI (2nd edn)_Text.indd 161 25/02/2021 08:09

reserves at the central bank. According to this story, deposits of agents at

Transactions of the private sector

M4921-ROCHON & ROSSI (2nd edn)_Text.indd 162 25/02/2021 08:09

Bank of the car purchaser

Bank of car purchaser Bank of car dealer

Assets Liabilities Assets Liabilities

of its balance sheet, but simultaneously, on the liabilities side, there is an

M4921-ROCHON & ROSSI (2nd edn)_Text.indd 163 25/02/2021 08:09

Bank of car purchaser Bank of car dealer

Assets Liabilities Assets Liabilities

In all payments systems, amounts due between participating financial insti-

M4921-ROCHON & ROSSI (2nd edn)_Text.indd 164 25/02/2021 08:09

Bank of car purchaser Bank of car dealer

Assets Liabilities Assets Liabilities

d) Money emerged historically as a means of payment, in its capacity to extinguish debt