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How is the money supply increased throughout years?

When the central bank wants to increase the money supply, it either lowers interest rates so that the demand for money increases (commercial banks are more likely to borrow money from the central bank to make loans to people and companies), or buys government bonds, paying with cash, in both cases increasing the amount of money in circulation. Now my question is: if loans are ultimately paid back by individuals and companies to commercial banks, thus withdrawing money from circulation (let us assume, for the sake of simplification, that there is no insolvency), and government bonds, or any other kind of bond that the central bank may have purchased ( except for perpetual bonds), are subject to maturity, meaning that an amount equal to the face value of the bonds has to be paid back by the debtor (in most cases the government) to the owner of the bonds (the central bank), thus withdrawing money from circulation, how is it possible that the money supply has increased throughout years?
I will be immensely grateful to whoever can explain to me the mechanism in detail, possibly giving references from reliable sources.
Yes, so you are referring to the so called “fractional reserve system”, where banks only keep a fraction of the deposits, the reserve requirement (RR) specified by the central bank, and are allowed to lend the rest: this process can take place several times, potentially ending up multiplying the initial deposit by (1/RR). If I’m getting your point right, you’re saying that the increase in lending activity, driven by the increase in demand for money, caused by the increase in real economic activity (output), resulted in an increase of issued loans and therefore circulating money, given that, as you said, not all loans are either issued or paid back at the same moment: am I correct?

That definitely makes sense, so thank you for that.
There is still something, though, that I find rather intriguing. Theoretically, if commercial banks stopped issuing new loans, and those already existing were gradually paid back, and the same happened for all the existing bonds (whether government bonds or
corporate bonds), what money would remain in circulation? Only that which is backed by physical assets?
(I am aware that such a scenario is completely unrealistic and would result in total paralysis of the economy, my question is just for the sake of academic speculation).


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2 Responses to "How is the money supply increased throughout years?"

  1. SDD says:
    Actually, the central bank increases the money supply by buying bonds. It cannot directly control the rates charged by commercial banks (unless the state also controls the banks).
  2. Spotty J says:
    Excellent fundamental question. Money is created when a bank issues a loan; yet money is erased as that bank loan principal is paid back. Somehow on net, the amount of money in the money supply tends to increase.

    Well it’s not as if all loans were suddenly issued at one moment in time, and we are sitting here watching them get paid off. Over time banks continue to issue new loans, even as previous loans are still gradually in the process of being paid off. And, you could go start a new bank, open a new branch. Take some deposits and start lending away.

    Some of the money borrowed from Bank A will wind up as a deposit at Bank B, allowing Bank B in turn to lend out a large fraction of that (creating new money), and so on… And that really is a key you may be missing. Borrowed money becomes the basis for additional borrowing.

    A given loan may take from a few years to 30 years to be paid off . Meanwhile that money circulates, becomes someone else’s income, some other bank’s deposit, hence their capital for additional lending.

    I don’t think it’s hard to see that, even assuming all money borrowed (created) is eventually paid off (erased), as time progresses lending activity causes the current money supply to increase.

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