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Definition: Circuitism

Circuitism also called as Monetary Circuit Theory pertains to understanding of money creation. It states that money is rather than being created exogenously by Central Bank, is created Endogenously by the banking sector.

The key difference between this and mainstream economic theories is that this theory states that economy creates money itself, rather than provided by some external agent. It emphasizes the role of banks and firms/companies in an economy more than the role of individuals. The Circuitism theory, like mainstream economic theory separates the money into two type – hard money: liquid assets which can be converted to liquid cash quickly and credit money. The theory states that the money created by the commercial banks is primary money rather than saying that the money is created by commercial bank. The theory also rejects concepts such as multiplier of money based on reserve requirements and neutrality of money.

Suppose you buy a loaf of bread, the mainstream economic theory says that it involves two activities ie bilateral transaction, between seller and buyer. But according to the cicuitism theory, there are parties to the transaction, the seller, buyer and the bank. So when buyer has to pay, his account in bank is debited while the sellers account is credited.

So the credit money is created from a loan that is extended, but this loan is not backed up by reserves towards reserve bank, but by a simple promise embodied in the loan.



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