The Determination of the Money Supply: Flexibility Versus Control

Abstract

During the last two centuries there have been four main approaches to analysing the determination of the money supply, to wit: (1) Deposits cause Loans, (2) The Monetary Base Multiplier, (3) The Credit Counterparts Approach and (4) Loans cause Deposits. All four approaches are criticized, especially (2) which used to be the standard academic model, and (4) which is now taking over as the consensus approach. Instead, I argue that banking is a service industry, which sets the terms and conditions whereby the private sector can create additional money for itself. The problem is that such money creation tends to be highly procyclical, so the question then becomes finding the best trade‐off between official control of that process and allowing sufficient flexibility for the private sector. I conclude by reviewing how Lord King's reform proposals, in his book on The End of Alchemy, might fit into this broader analysis.