But Most People Don’t Know How Banks Work–And Are Shocked When They Learn

Peter Dorman, one of my favorite economics bloggers, responds to the incredible hostility towards economics (personally, I find it no more corrupt than certain areas of medical science). He offers an example:

Check out the Uneconomics initiative and its “exposé” of how banks create money. Who could have imagined: private banks actually create money out of thin air when they make loans, and this creates the potential for economic volatility due to over- and undersupply. These secrets, supposedly covered up by sneaky economists and other elitists, are revealed by radical social critics, and we should be shocked, shocked.

Banking is a system that runs on make-believe and survives on ignorance.

Does it matter that a significant swath of the left thinks that standard stuff in a money and banking course is a great discovery that will shake capitalism to its foundations?

I fully agree with Dorman. It’s nothing that Kenneth Arrow didn’t describe. In 1958. But most people don’t realize that banks can treat lines of credit as deposits and thus ‘create’ money (that is, count lines of credit as reserves held by the bank, not as loans outstanding). And the idea that banks routinely lend money to each other if they have exceeded the amount of loans allow by their reserves would be shocking (banks in the U.S. are required to have deposits equal to ten percent of their loans, which are the ‘reserves’). In fact, the practical reality that banks are never constrained by their reserves unless the central bank desires it be so, since they can borrow money in the overnight market, or, failing that, can go to the central bank (‘the lender of last resort’) would also be shocking.

Most people, including some engaged in the popular discussion of economic issues, really believe that banks can only lend based on their deposits. (If it makes Dorman feel any better, most people who aren’t biologists have no idea what the neutral theory is or how integral it is to biology).

Consider this part of the ongoing adult education failure known as the U.S. corporate media.

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1 Response to But Most People Don’t Know How Banks Work–And Are Shocked When They Learn

  1. edivimo says:

    Yes, is shocking. I learned that like two years ago. And then I realised, almost instantaneously: the banks must be regulated with iron fist.

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