Where Deposits Come From
This goes against the grain of the usual way of describing bank lending, which suggests that banks "collect" deposits
and then "lend them out." That is not the way it happens at all. In a closed economy (or the world as a whole),
fundamentally, (8) deposits come from only two places: new bank lending and government deficits (9). Banks create
deposits when they create loans, as explained above. Governments also create deposits when they run budget deficits
because they are putting more money into the public's bank accounts than they are taking out. This net flow creates
new deposits in the banking system, which has its counterpart on the bank's balance sheet as an increase in reserves:
And on the central bank's balance sheet,
as we saw before.
Banks don't lend out of deposits; nor do they lend out of reserves. They lend by creating deposits. And deposits are
also created by government deficits.
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