Two Competing Models of Banking
The answer to whether deficits cause crises depends entirely on which model of banking is correct:
1. Loanable Funds Model
Core Assumption: Banks are intermediaries between savers and borrowers.
From mainstream textbooks:
“Commercial banks are the best-known type of financial intermediary. They take deposits from savers and use these deposits to make loans to those who have investment projects they need to finance.” - Mankiw (2016)
Key Characteristic: Loans appear as: - Assets of Households (who are the real lenders) - Liabilities of Firms (borrowers) - NOT on bank balance sheets as assets
Godley Table Structure (Loanable Funds)
Complete analysis requires three tables (Banks, Households, Firms) with each transaction appearing four times.
Private Banks:
| Flows↓/Stocks→ | Reserves | Households | Firms | \(Banks\) | A-L-E |
|---|---|---|---|---|---|
| Type | Asset | Liability | Liability | Equity | |
| Initial | 100 | 40 | 50 | 10 | 0 |
| Pay Wages | +Wages | -Wages | |||
| Buy Goods | -Consume | +Consume | |||
| Borrow Money | -Credit | +Credit | |||
| Pay Interest | \(Int_{Firms}\) | \(-Int_{Firms}\) | |||
| Pay Bank Fee | -Fee | Fee | |||
| Banks Spend | \(Spend_{Banks}\) | \(-Spend_{Banks}\) | |||
| ∫ Flows | 100 | 20+∫ | 70+∫ | 10 | 0 |
Households:
| Flows↓/Stocks→ | Households | \(Debt_{Firms}\) | \(HH_{Equity}\) | A-L-E |
|---|---|---|---|---|
| Type | Asset | Asset | Equity | |
| Initial | 20 | 0 | 20 | 0 |
| Pay Wages | +Wages | +Wages | ||
| Buy Goods | -Consume | -Consume | ||
| Borrow Money | -Credit | +Credit | ||
| Pay Interest | +\(Int_{Firms}\) | +\(Int_{Firms}\) | ||
| Pay Bank Fee | -Fee | -Fee | ||
| ∫ Flows | 20+∫ | 0+∫ | 20+∫ | 0 |
Firms:
| Flows↓/Stocks→ | Firms | \(Debt_{Firms}\) | \(Firms_{Equity}\) | A-L-E |
|---|---|---|---|---|
| Type | Asset | Liability | Equity | |
| Initial | 70 | 0 | 70 | 0 |
| Pay Wages | -Wages | -Wages | ||
| Buy Goods | +Consume | +Consume | ||
| Borrow Money | +Credit | +Credit | ||
| Pay Interest | -\(Int_{Firms}\) | -\(Int_{Firms}\) | ||
| Banks Spend | +\(Spend_{Banks}\) | +\(Spend_{Banks}\) | ||
| ∫ Flows | 70+∫ | 0+∫ | 70+∫ | 0 |
Basic Flows (Without Government)
Parameters and flows:
\[Wage_{Share} = 60\%; \quad V_{Firms} = 4; \quad V_{HH} = 12.5 \quad V_{Banks} = 1 \]
\[Int_{Rate} = 5\% \quad Fee_{Rate} = 10\% \quad Credit_{Rate} = 0\%\] \[GDP = {Firms} \times {V_{Firms}}\]
\[Wages = GDP \times Wage_{Share}\]
\[Consume = {Households} \times {V_{HH}} \quad (3)\]
\[Credit = GDP \times Credit_{Rate}\]
\[Int_{Firms} = Debt_{Firms} \times Int_{Rate}\]
\[Fee = Int_{Firms} \times Fee_{Rate}\]
\[Int_{Firms} = Debt_{Firms} \times Int_{Rate}\]
\[Spend_{Banks} = {Banks} \times {V_{Banks}}\]
Adjusting the credit and interest rates will change \(Debt_{Firms}\).
| Variable | Value |
|---|---|
| Loading… | — |
This system is sustainable with only private sector debt does not get too large. But the growth of GDP is slow, there is a slow growth in household net equity and no growth in the value of firms.
| ← Prev | Next: Adding Government Sector → |