A discussion of the importance of money and credit to an economy and how major expansions and contractions of credit can develop.
Last year, we saw on the newspapers a lot of information about credit crunch and how much it affected the economy. To answer to this discussion, I will explain the importance of the money and the credit in the economy, and then I will demonstrate what can expansion and contraction of credit can develop in the economy.
In an economy, money is important. It is a synonym of a wealthy economy. More we have money in the economy, more people spend their money because the prices are low, and more the firms produce goods and so on.
As we can see on the website of the Federal Reserve, the creation of money does not require a preliminary savings. A bank does not grant credits according to the deposits (liabilities or preliminary savings) but it is the credit placed which constitute the deposits. When a bank grants a credit to a not financial economic agent, a company or a household, the account of this one is increased by the amount of the credit. In return, he is put into debt by the amount of the credit. The bank provided to him bank money. The Bank borrows money to the Central Bank directly or thanks to intermediaries. These intermediaries help the lenders/savers (companies or pension fund who are too much money and want to invest) to meet the borrower/spenders (household or companies) who need money.
Banks are limited in their monetary creation by the fact that they have to hold certain percentage of notes and coins which could be asked by their customers. It is the Central Bank which controls this creation by allowing the banks to satisfy the demands of conversion of their customers. In accordance with Peter Howells and Keith Bain (Howells and Bain, 2007: 69-75), if the central bank thinks that there is too much money in the economy, she will increase her interest rates to the banks. Banks are profit- making organizations with