“It is surprising that there is any debate about how banks work: surely it is crucial to an understanding of the drivers of both the financial system and the economy”, reads The Financial Times, 8th June 2015.
The article refers to a working paper published recently by the Bank of England that points out that there is an enormous gulf between how mainstream economic theory views banks and the reality.
It explains that banks do not lend out money deposited by savers (the model that most economic textbooks propound) but instead they create deposits when they make loans and that central banks have actually limited control over how much money is pumped into the system in this way. The paper confirms what we explain in this video: that banks are not reserve-constrained.
The article quotes Ben Dyson, Head of Research at Positive Money:
It is important to widen understanding, because if regulators and policy makers are basing their views on the risks of another crisis occurring, or what might lead to one, on a model that shows banks will stabilise the economy, mistakes are likely.
You can read the whole article here.
(You are required to register to FT in order to read it.)