Money and banks (part 7)

Commercial banks

Currency inside banks is not money

The fact that currency inside commercial banks is not money may strike you as odd, but it is an important principle. The 100 dollar bill in the ATM will become money only at the instant you withdraw it. The reason is this. We want the money supply to measure how much is available for immediate consumption. But currency inside a bank cannot be used for consumption and this is why it is not counted in the money supply. Cash in the bank is not money, but the binary bits in the bank's computer system representing the balance in your checking account are!

An example may also illustrate this important fact:

• Eric has 100 euro - this amount is obviously part of the money supply as it is immediately available for consumption.

• Eric deposits 100 euro into his checking account. He still has 100 euro available for immediate consumption using Ins debit card and the money supply should not be changed by tins deposit (it is not - deposits are included in the money supply).

• Eric’s bank now has 100 euro more than before deposit. If we count currency inside the bank as money, the money supply would have increased by 100 euro by his deposit. This does not make sense as the amount available for immediate consumption has not changed.

• In the same way, withdrawing money from the ATM does not affect the money supply. When you withdraw money, currency outside banks increases while your checking balance decreases by the same amount.

Even though currency inside a bank is not money, it is still part of the monetary base. 100 euro inside the bank is obviously still worth 100 euro to the bank even though we do not include it in the money supply.