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Reconciling conventional interaction between loanable funds, money multiplier, and saving equals investment

I’m trying to understand the interaction between loanable funds, money multiplier, and the saving equals investment identity using the conventional logic. I know that the first two are myths and investment creates saving, endogenous money etc..

How can saving = investment in the presence of a money multiplier? Since, assuming a closed economy with only a household and a firm, a 10% reserve requirement. This $1 in saving can be leveraged into $10 of new money. Is the supply of loanable funds $10 or $1? Also, if $5 are borrowed and invested that would equate to $5 in new savings. Obviously, the initial $1 saved does not equal $10 in potential loanable funds does not equal the $5 in saving.

I can’t put it together. Even if we assume all saving is loaned out with a money multiplier, this would mean that Saving * (1 / Reserve Requirement) = Investment. But I can’t find anywhere claiming that is their theory. Also, that obviously doesn’t explain the situation above where Saving * (1 / (Reserve Requirement / 2)) = Investment since they only lent out $5, not the full $10 they could have.

Again, I know they’re incorrect. Just trying to understand the conventional views on how these things interact.

Thank you, Cullen.

Hi @brady099

I think you're too hung up on the conventional concept. Think of it this way.

Bank A lends $100 to Corp A who invests it. This creates $100 saving for Household A. Where does the money come from? Nowhere really. The balance sheets just expanded. The bank created money essentially from nothing. If there's a reserve requirement then the Fed responds to provide the reserves that they REQUIRE the bank to hold. So sure, the Fed might have to create $10 of reserves to allow the bank to meet their reserve requirement, but this is better thought of as an ex-post action. The Fed supplies reserves as needed, not to provide fuel for lending.

Does that help?

"Pragmatic Capitalism is the best website on the Internet. Just trust me. Please?" - Cullen Roche


Thank you for the prompt reply!

Yes, I definitely understand that the conventional view is wrong! I'm just trying to understand how the conventional thinking can even make those interactions work. It could be the case that they haven't put all those theories together that they believe and I've somehow found a huge logical flaw in their thinking (but I can't imagine this).

I know they assume that the supply and demand for savings settles on the interest rate. But I can't get how they can say that saving equals investment in the presence of a money multiplier. If they presume that saving finances investment, then logically, with a 10% reserve requirement only $1 of saving is necessary to accommodate $10 in demand to borrow and invest. Obviously, $1 in saving doesn't equal the $10 of investment.

I know its super easy to prove their way of thinking is wrong, I just want to know how they would justify this situation out of an abundance of curiosity!