Dominant Money. The Bank Money Regime

The banking sector’s pro-active money creation by way of credit extension dominates the monetary system. Central banks have little choice but to accommodate in hindsight the facts the banks have created in advance. Adding to this, the new third-level money surrogates based on bank money, as well as the now large sector of shadow banks that operates predominantly on bank money, the entire system has become a veritable bank money regime in which central banks act as an auxiliary body of the banking sector. Since banks under normal conditions need central-bank reserves in the amount of only a small fraction of the bank money they create, the transmission lever of monetary policy has become short and its effectiveness weak. In recent decades, lending and investment on the basis of both the banks’ monetary credit and shadow banks’ intermediary credit went for the most part into non-GDP finances that do not contribute to fund real-economic output. This resulted in extraordinary asset inflation, bubble building and proneness to crisis. In the bank money regime, financial markets tend to overshoot in positive-feedback loops rather than achieving self-limitation in negative-feedback loops.