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A Simple Model of Money and Banking

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This article presents a simple environment that has banks creating and lending out money. The authors define money to be any object that circulates widely as a means of payment and a bank to be an agency that simultaneously issues money and monitors investments. While their framework allows private nonbank liabilities to serve as the economy's medium of exchange, they demonstrate that the cost-minimizing structure has a bank creating liquid funds. In practice, the vast bulk of the money supply consists of private debt instruments issued by banks. Thus, their model goes some way in addressing the questions of why private money takes the form it does, and why private money is typically supplied by banks.

Suggested citation: Andolfatto, David, and Ed Nosal. “A Simple Model of Money and Banking,” Federal Reserve Bank of Cleveland, Economic Review, vol. 37, no. 3, pp. 20-28, 12.01.2001.

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