Abstract for:Money Stock Equals Total Debts by Banks -- Theory and Flow of Funds Analysis in Japan

Money stock is defined as the sum of cash, demand deposits, and time deposits. Its quantity and behavior decisively affect various macroeconomic variables such as GDP and price level. Yet its true nature has been obscured in economics. Where does it come from? How does it get created, and how much? In this paper we apply Accounting System Dynamics framework to investigate the process of money creation by building a simple model, then apply theoretical insights obtained to a case study on the Flow of Funds Accounts in Japan since 1980. It is then found that money stock equals the total debts by banks held by domestic non-banking sectors such as non-financial corporations, households, and the government. While an intermediate divergence between two variables during 1994-2015 indicates a room for improvement in precision, results from current analysis demonstrates that the nation’s money supply is determined by private and public debts financed by the banking sector, confirming the consistency of deposit creation theory at a macroeconomic scale. In other words, we have theoretically and empirically confirmed that money is created when public and private sectors come to borrow at interests under the current system based on fractional reserve banking.