Unveiling the Hidden Engine: Banks' Unrivaled Power in the Economy
Rethinking the Role of Financial Institutions in the Economy
Prominent economist Richard Werner recently stirred debate by asserting that widely accepted economic textbooks fundamentally misinterpret the function of banks. He emphasizes that these institutions are not merely conduits for existing funds but possess an unparalleled capacity to generate new money, a crucial aspect often disregarded by economists. This oversight, Werner argues, leads to flawed analyses, particularly as the American economy experiences a downturn and the Federal Reserve contemplates interest rate adjustments.
Deconstructing Traditional Banking Theories and Introducing the Credit-Creation Model
Werner meticulously outlines three distinct perspectives on banking. The first, the "intermediation theory," posits that banks primarily collect deposits and then extend them as loans. The second, termed the "fractional-reserve theory," suggests banks retain a fraction of customer deposits as reserves while lending out the remainder. However, Werner champions a third viewpoint, the "credit-creation theory," which posits that new money is actively generated by banks each time a loan is issued.
The Impact of Overlooking Banking's Unique Monetary Function
Werner critically notes that macroeconomics has struggled for centuries due to its failure to accurately incorporate the banking sector. He points out that proponents of the credit-creation concept were once dismissed as eccentric, a sentiment echoed by historical economic figures. This persistent exclusion of banks' intrinsic monetary function, he contends, is the primary reason why economic forecasts frequently miss critical turning points.
The Current Economic Climate and the Significance of Werner's Insights
This discussion emerges at a pivotal moment, as the demand for credit diminishes and lending standards tighten. Recent reports indicate a significant reduction in small-business loan applications, and a major financial institution observed a decline in average loan volumes, partly attributed to challenges in commercial real estate. Analysts are now anticipating multiple rate reductions by the central bank following a slowdown in job growth. Acknowledging banks' role in creating money, Werner concludes, is essential for resolving numerous perplexing issues within the field of economics, especially as policymakers navigate current economic challenges like subdued growth and persistent inflation.