Money-creating banks and the market price of time (updated draft coming soon)
Abstract: I demonstrate that commercial banks’ creation of money influences everyday real investment and output. Using a cash-in-advance model extended with privately issued money, I show that the risk-free real interest rate can be persistently pushed down when commercial banks create demand-deposits circulating as means of payment. This can lead to Pareto inferior equilibria and a phenomenon I call the disconnected real interest rate: namely, a real interest rate that is no longer a function of agents’ marginal rate of substitution of consumption across time. Moreover, the cheapness of credit creates a credit hungry society, characterised by maximal household and firm borrowing and minimal bank capital.
Money-creating banks and the effect of monetary policy
~ Awarded research grant by the Royal Swedish Academy of Sciences ~
Abstract: This paper shows that the presence of money-creating commercial banks can change both the magnitude and direction of monetary policy’s impact on key economic variables such as employment and aggregate output. Commercial banks’ creation of money effectively acts as endogenously created, long-run price stickiness due to its downward pressure on the nominal interest rate, which in turn makes this nominal rate unable to adjust in accordance with the inflation rate. Consequently, the presence of money-creating commercial banks can transform the steady-state real interest rate from being exclusively determined by agents’ rate of time preference to being influenced by the constant growth rate of the stock of central bank money. This gives central banks a more persistent and powerful role in influencing real interest rates than hitherto acknowledged.
Connectedness to money inflow and the structure of production
Abstract: I develop a network model of production and show that the size of a given sector is influenced by how close this sector is to the source of money inflow, where distance is measured in number of transactions from the sector into which the newly created money is initially injected. That is, some sectors can become ”artificially large”—in terms of input into and output from—due to their closeness to the source of money inflow. This holds even when prices are perfectly flexible and all agents are perfectly informed on current and future changes in the money supply, including their source. Examples of sectors typically close to the source of money inflow are financial markets and the housing market.