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Credit creation


A name for the process by which the banks collectively can make loans in excess of extra base money they receive. If base money increases, through a balance-of-payments surplus or open market operations by the central bank, this will mostly be paid into somebody’s account with a commercial bank. The bank concerned can then lend most of the extra money out, which in turn raises deposits at other banks. Collectively, if banks hold 100n per cent of their total assets in base money, they can increase loans, and thus total deposits. By up to £1/n for every £1 of extra base money. How close to 1/n the credit multiplier actually is depends on the proportion of the total money supply which the banks’ customers choose to hold as cash rather than bank balances.


Reference: Oxford Press Dictonary of Economics, 5th edt.