Debunking "Loanable Funds"

By Mark Dempsey

Conventional economics promotes the "Loanable Funds" economic theory. It says the economy is essentially a zero-sum game producing no new resources, goods, services, or money. When governments spend, they "crowd out" the (always productive!) private sector, denying it resources, and when governments borrow, they remove "loanable funds" from the market, making it more expensive for the private sector to borrow. Governments apparently can never create money, or mobilize idle resources, or create new ones--please ignore that 80% of the basic research making the iPhone possible was government-funded.

 

If you're interested, one accessible retelling of this bit of propaganda is Wikipedia's otherwise useful account of Government Spending. For a point-by-point answer to the arrant nonsense of the main page, take a look at the Talk tab of that same page. It debunks both the economic theory and Wikipedia's supposed editorial objectivity.

 

A LinkedIn post debunking the “Loanable Funds” theory is what prompted me to write the above. The post in its entirety appears below. 

 

Of course, those persuaded of conventional economics persist in their disagreement no matter how counterfactual their position, just as physicists educated as Newtonians dismissed Max Planck's discovery of the quanta of quantum mechanics. I've read that quantum mechanics has been proven experimentally accurate within two parts per billion. I've also read that Newton's physics predicts the electrons will spiral into the nucleus of atoms, and the universe will die. Never mind, the conventional mind is made up!

 

Clinging to discredited science isn't that new. Pythagoras said all numbers were rational (expressable as a fraction) until Hippias pointed out that a right triangle with two sides of length one would have a hypotenuse of the square root of two--definitely not a rational number. The report is that Pythagoras' disciples threw Hippias off a cliff and killed him. Heretics and witches were burned at the stake, and the science and literature of the New World were as often as not consumed in flames too by its conquerors. Copernicus published his refutation of the geocentric solar system posthumously, and Galileo was put under house arrest for politely agreeing. Planck himself said, "The truth never triumphs; its opponents simply die out. Science advances one funeral at a time." 

 

Here's the LinkedIn post (slightly edited):

 

There isn't competition for funds!!! Oh, My Dear Lord!!! When will people understand that the "Loanable Funds Theory" is BS?

 

Money Creation - Bank of England (2014) and Bundesbank (2017) papers .
https://www.bankofengland.co.uk/quarterly-bulletin/2014/q1/money-creation-in-the-modern-economy
https://www.bundesbank.de/resource/blob/654284/df66c4444d065a7f519e2ab0c476df58/m/2017-04-money-creation-process-data.pdf

[The two papers linked above are from the UK and German central banks, not some crackpot outlier. The commenter helpfully provided the following graphic about how banks actually work]

Here's economist Steve Keen's short take on this:

Textbooks still teach that a government deficit reduces the supply of money and crowds out private investment. Students learn that private saving plus public saving make up the supply of loanable funds. When the government borrows more, the supply shifts left, interest rates rise, and investment falls. So deficit spending designed to help the economy is said to hurt it. That is why politicians cut education and welfare and call it growth-friendly. They actually believe the textbook. The simplest double-entry accounting shows the opposite. Taxation takes money out of deposit accounts. Spending puts money in. A deficit increases the stock of money. So why do practical politicians keep following a model that gets this basic point backwards? #Economics #Austerity #GovernmentDebt #Eurozone #SteveKeen

— Prof. Steve Keen (@ProfSteveKeen) November 13, 2026