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This paper studies the role of banks’ money creation in monetary transmission. I develop a monetary-search model in which the demand for the monetary base and the money multiplier are endogenously determined through the banks’ money creation channel. Both the model and data show that short-term policy rates and interest on reserves play distinct roles in monetary transmission. I evaluate the theory by matching it with data, and the calibrated model can account for the evolution of the quantity of reserves, excess reserves, and the money multiplier from 1968 to 2015.

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This paper develops a dynamic monetary model to study the (in)stability of the fractional reserve banking system. The model shows that the fractional reserve banking system can endanger stability in that equilibrium is more prone to exhibit endogenous cyclic, chaotic, and stochastic dynamics under lower reserve requirements, although it can increase consumption in the steady-state. Introducing endogenous unsecured credit to the baseline model does not change the main results. This paper also provides empirical evidence that is consistent with the prediction of the model. The calibrated exercise suggests that this channel could be another source of economic fluctuations.