Why are bank deposits money?, Macroeconomics

Money is anything which is acceptable in settlement of a debt. But, paradoxically, the main asset used to settle debts in modern economies is other debts. After all, bank deposits are liabilities that the banks owe to their customers. Furthermore, we have seen that banks create liabilities against themselves when they make loans to their customers. In so doing, they are exchanging a debt which is not money for one which is money because bank deposits are acceptable in settlement of a debt. In other words, when a bank grants a loan it is effectively buying a debt which is not usable as money - otherwise it would be spent - in exchange for a debt which is usable as money. So why are banks able to create money? The answer is that their liabilities are acceptable in settlement of a debt because everyone has confidence that, on demand, these liabilities can be converted into cash. So long as this confidence is maintained, bank liabilities will always be acceptable in settlement of a debt, and will always therefore be money.

Posted Date: 9/18/2012 6:12:54 AM | Location : United States







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