How does paying off debt to the bank work? So, I understand that banks create money by making loans which end up as deposits. But what I don't get, is how paying off debt works in the big picture. Let me explain.
Let's say Jim got a loan of \$100 from the bank. He now owes the bank \$100 + \$10 interest. Where is he getting the money to pay off the loan? All of the money in the economy is created by the bank. So in this simplified example does he get it from someone else who took out a loan? Multiple people? Let's say he sold apples to Sarah and Bob for \$60 each. He would be able to pay the \$110 he owes to the bank. But Sarah and Bob would have had to take out loans, so they would also be in debt to the bank. Where would they get the money to pay off their debt?
Does the economy depend on a majority of people being unable to pay their debt? But if that was the case, how would the bank make money? I must be missing something here.
The total nominal income of the domestic economy is equal to nominal GDP growth. This chart shows nominal GDP growth for the U.S.: link to FRED graph.
If you dig into the numbers, we see that nominal GDP growth is often higher than most interest rates. So total income is growing faster than interest costs.
You cannot look at one loan in isolation and hope to make sense of total flows of income. At any given time, new loans are continuously made, while old loans are paid down. Mortgages are typically the largest household sector debt in aggregate. New buyers get large mortgages, while existing homeowners slowly pay down debt. The net change is normally positive, which effectively finances construction. Construction in turn adds to GDP and hence incomes. This story is repeated in different forms across all types of debt.