Question

what is the impact of money creation by commercial banks on national income explain?

Answer 1

National Income (Y)  can be expressed as the sum of: 1) Private Household Consumption 2) Government Spending and 3) Private Investment

i.e. Y= C+ I+ G

Also, Money creation (money supply) is inversely proportinal to the intesrest rate (r)

Therefore, as commercial banks increase Money Supply, the interest rate falls (r declines). As more money is available at lower interest rates, household will increase their consumption of goods (especially the goods that they purchase on loans, like consumer durables- ACs, TV, Fridge, Cars). Hence C increases.

Also, more investment projects will be taken up as money is available at lower interest rates- builders will invest in building infrastructure projects and roads and the Investment factor (I) also increases.

Thus, as C and I increase due to this money creation process, the national income (Y) will also increase.