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Mainstream economists do not understand banking

John Hermann

The following quotes from famous heterodox economists and leading central bankers reveal that they understand something about the nature of banking which we know is simply denied by many mainstream economists. Namely, that banking institutions around the world create new bank credit money in the process of advancing retail loans, as well as when they buy goods and services from the non-bank private sector.

Moreover, as has been pointed out on many occasions by ERA patron Prof Steve Keen, the change in net debt arising from bank lending makes a significant contribution to economic performance and aggregate demand.

The fact that so many neoclassical economists have failed to grasp these important aspects of the mechanics of modern banking, as well as the reality that money creation by banks occurs endogenously (rather than being under the direct control of the central bank, as many mainstreamers seem to assume) is nothing short of a major intellectual scandal. And their ignorance of the underlying mechanics of banking is hindering their ability to adequately analyse and deal with the world’s pressing economic problems.

In the real world, banks extend credit, creating deposits in the process, and look for the reserves later.
Federal Reserve Bank of New York (1969)

The financial crisis of 2007/08 occurred because we failed to constrain the private financial system’s creation of private credit and money.
Lord Adair Turner, former chairman of Financial Services Authority, United Kingdom

The process by which banks create money is so simple that the mind is repelled.
John Kenneth Galbraith – Economist

Banking is not money lending: to lend, a money lender must have money.
Hyman Minsky – Economist

Of all the many ways of organising banking, the worst is the one we have today.
Sir Mervyn King – Former Governor, Bank of England

The previous issue of ERA Review contains two excellent articles, by Steve Keen and Geoff Davies, which flesh out the abysmal failure of the economic mainstream to reappraise their theoretical models in the light of their inability to predict the financial crisis of 2007-8. And with very few exceptions, their second failure has been their inability to take a big bite of humble pie, a necessary precursor for bringing their models into alignment with the basic realities of banking as understood by central bankers.

John Hermann is the ERA network editor

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