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Endogenous Money Theory

Endogenous Money Theory posits that the supply of money in an economy is determined by the demand for loans rather than being controlled by a central authority, such as a central bank. According to this theory, banks create money through the act of lending; when a bank issues a loan, it simultaneously creates a deposit in the borrower's account, effectively increasing the money supply. This demand-driven perspective contrasts with the exogenous view, which suggests that money supply is dictated by the central bank's policies.

Key components of Endogenous Money Theory include:

  • Credit Creation: Banks can issue loans based on their assessment of creditworthiness, leading to an increase in deposits and, therefore, the money supply.
  • Market Dynamics: The availability of loans is influenced by economic conditions, such as interest rates and borrower confidence, making the money supply responsive to economic activity.
  • Policy Implications: This theory implies that monetary policy should focus on influencing credit conditions rather than directly controlling the money supply, as the latter is inherently linked to the former.

In essence, Endogenous Money Theory highlights the complex interplay between banking, credit, and economic activity, suggesting that money is a byproduct of the lending process within the economy.

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