On some principles to fix the quantity of bank money

Abstract

The chapter describes the equilibrium of the banking system in a modern economy, with both a central bank and a commercial banking system. Equilibrium conditions are set out for the markets in, first, base money issued by the central bank and, secondly, money in the form of bank deposits (‘the quantity of money’) created by commercial banks. The heart of the chapter is a geometrical construction demonstrating the money creation process in a modern banking environment. A four-quadrant diagram is suggested, because quadrants with isosceles triangles neatly represent the equality of assets and liabilities in financial institutions that is also a necessary feature of bank balance sheets. The resulting ‘apparatus of thought’ is intended to facilitate discussion between economists with different views on both the money creation process and the role of money in the determination of macroeconomic outcomes.