Money Creation and Banking: Theory and Evidence

TL;DR

This paper develops a monetary-search model to analyze how banks' money creation influences monetary transmission, showing that reserves are affected by interest rate policies and that short-term rates and interest on reserves have distinct roles.

Contribution

It introduces a model endogenizing demand for the monetary base and the money multiplier, aligning theory with empirical data on reserves and the money supply.

Findings

Reserves are influenced by interest rate policy even with ample reserves.

Short-term rates and interest on reserves serve different roles in monetary transmission.

The calibrated model matches observed data on reserves, excess reserves, and the money multiplier.

Abstract

This paper studies the role of banks' money creation in monetary transmission. I develop a monetary-search model where demand for the monetary base and the money multiplier are endogenously determined through banks' money creation. The model and data show that reserves are not independent of interest rate policy, even with ample reserves. Furthermore, short-term rates and interest on reserves play distinct roles in monetary transmission. I evaluate the theory by matching it with data, and the calibrated model can account for the evolution of reserves, excess reserves, and the money multiplier