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The include cash and central bank reserves as well

The reserve ration in the UK was known as a
liquidity ratio. This required banks to hold liquid assets equal to a
percentage of their deposits. So if a liquidity ratio, were set at 10% then a
bank with £100 would hold £10 in liquid assets. The difference between this
type of ratio and the normal reserve ratio is the actual term liquid assets
which include cash and central bank reserves as well as government bonds. While
the reserve ratio requires banks to hold cash and central bank reserves in
proportion to the total balance of their customer’s bank accounts, a liquidity
ratio allows banks to use this cash to buy bonds. This also counts towards the
liquidity ration meaning that the bank can not hold any cash of central bank
reserves and still meet the ratio. When a bank uses the central bank reserves
to buy bonds, the reserves belong to another bank. This means that they are not
removed from the circulation. As a result, the liquidity ratio as appose to the
reserve ration has no limiting effect on the total amount of money that the
banking sector as a whole can create.

Money can be generated and circulated in various
ways. One could state that a vast quantity of the money produced comes from
Banks where they make loans as well as the interest rates applied to them. In
regard to this, it’s not only the big commercial banks which create this, but
smaller banks also contribute the percentage of money being generated. This is
done through fractional reserve banking and the multiplier effect.

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Fractional Reserve Banking is when the Bank only reserves a fraction of
the reserves which have been deposited. This allows Banks to give out loans on
interest but keeping enough money to allow depositors to withdraw. The Reserve
Ratio is the fraction of deposits the Commercial Banks set aside as reserves.
If someone wanted to keep their money safe, they would deposit their money into
a bank. If a labourer had £10,000, they might want to deposit the money into a
bank to keep it safe. The bank now has a liability over the £10000 because that
money is now owed to the labourer. At some point in the future, they may return
to ask for the £10000 which was deposited. However, this money could be an
asset to the bank. Through this, the bank would put some money aside as
reserves, and in this case, 10% (£1000) could be put aside in case the labourer
returns for some of that money. The rest of the 90% (£9000) is lent out to a
borrower who is running a particular project or business. However, the borrower
may use this money to pay workers wages. These workers may have the same idea
as the previous labourer and store their money in the bank and essentially,
that £9000 is returning to the bank as a deposit. The bank could then lend some
of that money out again but at the same time keep some money aside as reserves.
In this case, we can say another 10% (£900) is put aside and the other 90%
(£8100) it lent out towards another project or business. Once again, the money
is put towards workers, and now they own £8100, and they too decide to deposit
their money into the bank. The bank may decide to stop lending out money in
which now the £8100 are now reserves. It is important to remember that these
are demand deposits which means that workers and labourers can ask for their
money back at any given time. The deposits need to be paid back as liabilities
and the assets which have been loaned out to be paid back to the bank with
interest. In essence, the bank still holds £10,000 but have £27100 in
liabilities. This is the multiplier effect which represents the idea that money
is being created and the money supply.

In 2006, the amount
of money created by banks was 80 times bigger than base money. When banks
panicked during the crisis and refused to lend, the Bank of England pumped a
load of extra base money through the scheme known as quantitative easing. This
shows that there is no real connection with the amount of central bank reserves
and base money and how much money the banks are able to create.

In 2006, the amount of money created by banks was
80 times larger than base money. When banks panicked during the crisis and
refused to lend, the Bank of England pumped a load of extra base money through
the scheme known as quantitative easing. This shows that there is no real
connection between the number of central bank reserves and base money and how
much money the banks are able to create.

The financial crisis in the United Kingdom of
2008-2009 was due to the creation of too much money. This pushed up housing
prices and caused speculation on the financial markets. As previously
discussed, every time a bank makes a loan, new money is created. The build-up
financial crisis involved banks creating a huge amount of new money by making
loans and within just seven years, the amount of money and debt in the economy
had doubled. This money was used to increase housing prices and cause
speculation on the financial markets. A small proportion of the trillion pounds
created by banks between 2000-2007 went to the business outside of the
financial sector. These involved, 31%  of
the proportigoing to residential property and as a result, this pushed up
housing prices, and 20% went to the commercial real estate. A further 32% went
to the financial sector which resulted in those same markets imploding during
the crisis, and a further 8% went into credit cards and personal loans.
Interest had to be paid on all the loans which the banks had made, and as the
debt was rising quicker than incomes, this resulted in some people struggling
to keep up with repayments. At
this point, they stopped repaying their loans, and banks found themselves in
danger of going bankrupt. As the former chairman of the UK’s Financial Services
Authority, Lord (Adair) Turner stated in February 2013: “The financial crisis
of 2007 to 2008 occurred because we failed to constrain the financial system’s
creation of private credit and money.” This process caused the financial
crisis. Straight after the crisis, banks limited their new lending to businesses
and households. The slowdown in lending caused prices in these markets to drop,
and this means those that have borrowed too much to speculate on rising prices
had to sell their assets to repay their loans. House prices dropped, and the
bubble burst. As a result, banks panicked and cut lending even further. A
downward spiral thus begins and the economy tips into recession.

After the crisis, banks refused to lend money
which led to the economy to shrink. This is because banks only lend when they
are confident that they will be repaid. When the economy is doing badly, banks
prefer to put a limit on their lending. Although they reduce the amount of
loans which they make, the public still have to keep up with the repayments on
the debts which they already have. The issue occurring was that when money is
used to repay loans, that money is ‘destroyed’ and disappears from the economy.
Just like a new loan
creates money, the repayment of bank loans destroys money. Banks making loans
and consumers repaying them are the most significant ways in which bank
deposits are created and destroyed in the modern economy (Thomas, 2014).

A heterodox theory of
money emphasizes the impact of government policies and activities on the value
of money. The early-20th-century German economist Georg Friedrich Knapp first
developed the theory of chartalism, which defines money as a unit of account
with value that is determined by what the government will accept as payment for
tax obligations. In other words, chartalism states that money does not have
intrinsic value, but is given value by the government.

 

Money is something we all hold value to. Without
this, it will be impossible to survive. This is evident from the adaptations
from the simplest forms of barter which involved wheat and grains to the most
complicated forms of money which take the form of electronic central bank
reserves. Too much money however, can cause speculation and problems on the
market. This was evident when a lot of money was generated from banks through
their loans. In the event of loans being repaid faster than banks giving out
loans, the economy slows down and prices decrease. The economy then risks into
slipping into a ‘debt-deflation’ spiral, where wages and prices fall but debt
does not change in value and as a result, debt increases.

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