A fundamental fallacy accepted as fact throughout most of the economic and political communities is private debt is better for the economy than public debt. It is considered a fact beyond dispute that private debt stimulates an economy which leads to expansion while public debt is always a net drain on an economic system since it diverts money from the private sector.
In reality it doesn't matter who borrows the money: The economy cannot tell and doesn't care. To understand why where the borrowed funds originate does matter to the economic system, you have to understand fractional reserve banking.
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In a fractional reserve banking system the banking system can create and lend dollars, that is, purchasing power, out of thin air. Let's assume the current reserve requirements are 10%. This sounds like if a bank has one dollar in new deposits it can only lend ninety cents since it needs to hold ten percent of its deposits in reserve. And this would be true if there were only one bank. But when Bank A lends the ninety cents most, if not all the money, winds up in another account at another bank increasing its reserves by ninety cents. That bank holds onto $0.09 as reserves and lends the $0.81 which ends up in another account at Bank C. Bank C adds $0.08 to its reserves and lends the $0.73. As you can see, that original $1.00 increase in reserves has led to a substantially higher increase in purchasing power. This increase in purchasing power can be inflationary. After all, that is part of the traditional definition of inflation: An increase in purchasing power relative to the goods and services available for purchase. In reality, it's what this created money purchases that determines the benefit or damage to the economy.
If the created purchasing power finances a productive investment, a new factory producing solar panels for example, the new money is backed by real goods available for purchase and the inflationary pressure is minimal or non-existent. But if the new money finances a service such as haircuts or non-productive investments, then we have a problem. There's new money floating about the economy, feeling the full effect of the monetary multiplier, but no new goods or services are available for purchase.
That's why, of the two factors which do matter to the economy, the second, where the money is going, matters most. We can borrow money to initiate new production or we can borrow money to simply maintain the status quo. The difference between the two matters a great deal to the economy. But, again, it doesn't really matter whether it's the government doing the borrowing or if it's the private sector. Either can finance production, which is beneficial, or economic consumption, which is detrimental to the economy.
In reality it doesn't matter who borrows the money: The economy cannot tell and doesn't care. To understand why where the borrowed funds originate does matter to the economic system, you have to understand fractional reserve banking.
We are very grateful for your visit on this blog, please you may download the files you need here and of course free and is very important!
Download Questions of Ekonomi for UMB PTN
Download Questions Package 1
In a fractional reserve banking system the banking system can create and lend dollars, that is, purchasing power, out of thin air. Let's assume the current reserve requirements are 10%. This sounds like if a bank has one dollar in new deposits it can only lend ninety cents since it needs to hold ten percent of its deposits in reserve. And this would be true if there were only one bank. But when Bank A lends the ninety cents most, if not all the money, winds up in another account at another bank increasing its reserves by ninety cents. That bank holds onto $0.09 as reserves and lends the $0.81 which ends up in another account at Bank C. Bank C adds $0.08 to its reserves and lends the $0.73. As you can see, that original $1.00 increase in reserves has led to a substantially higher increase in purchasing power. This increase in purchasing power can be inflationary. After all, that is part of the traditional definition of inflation: An increase in purchasing power relative to the goods and services available for purchase. In reality, it's what this created money purchases that determines the benefit or damage to the economy.
If the created purchasing power finances a productive investment, a new factory producing solar panels for example, the new money is backed by real goods available for purchase and the inflationary pressure is minimal or non-existent. But if the new money finances a service such as haircuts or non-productive investments, then we have a problem. There's new money floating about the economy, feeling the full effect of the monetary multiplier, but no new goods or services are available for purchase.
That's why, of the two factors which do matter to the economy, the second, where the money is going, matters most. We can borrow money to initiate new production or we can borrow money to simply maintain the status quo. The difference between the two matters a great deal to the economy. But, again, it doesn't really matter whether it's the government doing the borrowing or if it's the private sector. Either can finance production, which is beneficial, or economic consumption, which is detrimental to the economy.
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