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Abstract

A system dynamics simulation model has been developed to describe the most important mechanisms governing the physical output of goods and services in the economy in interaction with the financial system. The model aims to reproduce the dynamic behaviour, in particular boom-bust cycles, of the current financial-economic system in which money is created as debt. The model is able to reproduce the basic system variables rather well, including the recession due to creation of credit for non-productive purposes, notably mortgages. The model thus confirms Werner’s credit creation theory of banking and a modified form of Minsky’s instability hypothesis of decentralized money creation by commercial banks causing boom-and-bust behaviour. The resulting uncertainty and volatility and the induced short-termism are obstacles for sustainable economic development pathways.