Preface:
The commercial banking sector through its role of granting and creating credit in the money creation process has a large influence on the overall macro-economy. Specifically, their directing of credit has a large impact on what type of transactions happen in the economy. The majority of loans that banks grant go towards existing assets–mainly real estate. This means that the majority of banks’ credit creation goes towards unproductive transactions or transactions which don’t increase GDP (The purchase and sale of existing real estate assets does not add to GDP).
Write at least two paragraphs answering the following questions:
- Given that the majority of created credit goes towards existing assets, what affect do you feel this has on asset price inflation?
- Why do you think that banks grant the majority of their loans to finance the purchase of existing assets or unproductive transactions? (Hint: Remember banks are profit maximizing firms and take collateral into account when granting loans)