Throughout this economic crisis much has been written criticizing the banks and about how to increase their regulation. However, I have seen nothing recognizing their role in the creation of money. The closest has been when some officials have complained that banks are not making enough loans. Yet banks are essential to our exchange of goods and services – to the way we live.
As most people who have studied economics know, or should know, when the banks make a loan they create money and when the loan is repaid the money disappears but is recreated when the money is re loaned. Further when the central bank purchases government bonds (or other debt) this too creates money. But this is called high-powered money because it is subject to a multiplier as it works its way through the banking system. The multiplier depends on the ratio of reserves that banks are required or decide to keep to protect against losses or runs on the bank.
When banks have to write off loans this reduces the money supply. The same applies when they decide to increase the percentage of reserves they keep. The result is a decrease in the money supply which is required to facilitate the exchange of goods and service. People are now calling it a credit crunch.
Are there other ways to create money?
One way is the local exchanged trading system (LETS) (http://en.wikipedia.org/wiki/Local_Exchange_Trading_Systems) where people earn credits by providing goods or services to others in a group. I think these credits serve the same purpose as national money supplies which are mostly computer entries. An interesting feature of the LETS system is that it creates money upon which no interest is charged. A not so interesting feature is that every transaction is recorded. A national LETS system could be a big step towards 1984.
Another possibility is to incorporate money creation into a scheme to give subsidies to consumers rather than producers possibly in the form of a guaranteed annual income.
It appears the current way our economy creates money has broken down. Thus it could be worth looking for other ways to create money.