CREDIT CREATION OF MONEY AS A FAILURE OF COMMERCIAL BANKS´ INCENTIVES

Abstract

This paper focuses on the mechanism of money creation in the fractionalreserve banking system. The aim of this paper is to enlighten the origin of money supply, or more precisely to analyse incentives of the institutions participating in the process of money creation of the whole money stock. Following from this, the paper refers to commercial banks as the most serious destabilizing factor of purchasing power of money in the several last decades. Attention is given to factors which influence commercial bank to supply credit and also to the factors, which create demand for this credit. In its second part the study focuses on the failure of incentives resulting from commercial banks actions, which are responsible for the continuous decrease of purchasing power of money. The paper concludes with alternative proposal of monetary system based on free banking, which is capable of preventing the aforementioned incentives’ failure of commercial banks.Inflation, inside money, free banking, fiduciary money, fractional reserve system, failure of incentives