The Role of Credit Expansion and Debt Circulation in Economic Growth

Abstract

In this paper, we introduced a simple money exchange model including agents with minimal intelligence and one representative commercial bank as a showcase for the money creation process in the modern economy. Using this econophysics model with basic behavioral assumptions, we can identify the circulation of debt and money in a credit economy, and measure their velocities separately. We thus discerned two different ways of how debt can contribute to economic growth — first from credit expansion and then its circulation. The explanatory and predictive power of both the level and velocity of stock variables (i.e. money stock and outstanding debt measures) in our model are statistically scrutinized with US macroeconomic data from 1959 to 2015. This study manifested that credit growth is a necessary but not sufficient condition for economic growth: the velocity of that money and debt is equally important in our current economy.