Explain the process of credit creation that happens through the banking system of an economy, if the mathematical value of money multiplier in an economy during a given period of time is 8. Clearly mention all the assumptions that you have used while describing the process of credit creation.
Answers
Answer:
Demand deposits are an important constituent of money supply and the expansion of demand deposits means the expansion of money supply. The entire structure of banking is based on credit. Credit basically means getting the purchasing power now and promising to pay at some time in the future. Bank credit means bank loans and advances.
A bank keeps a certain part of its deposits as a minimum reserve to meet the demands of its depositors and lends out the remaining to earn income. The loan is credited to the account of the borrower. Every bank loan creates an equivalent deposit in the bank. Therefore, credit creation means expansion of bank deposits.
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