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Money creation in the modern economy (2014) [pdf]

bankofengland.co.uk

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Re: Money creation in the modern economy (2014) [pdf]

#101

Post by ubercow13 »

kgwgk wrote: post #97
louloulou wrote: post #96

Earlier quoted context omitted.

I shouldn't have quoted $1M in deposits, because I meant $1M in reserves. Since deposits can only become reserves if they are the liabilities of other banks that get settled by transferring reserves to your bank's reserve account. My only point was individual banks, can lend up to whatever the reserve requirement is. If it was 10%, $1M in reserves at the central bank means the bank can could make $10M worth of loans.…

> My only point was individual banks, can lend up to whatever the reserve requirement is. If it was 10%, $1M in reserves at the central bank means the bank can could make $10M worth of loans. Do we disagree on this point? I agree that bank can lend up to whatever the reserve requirement is. But the next sentence is extremely misleading at best. For that bank with $1m in deposits and $1m in reserves before any lending…

>the bank can make $9m worth of loans provided that the recipients of the loans never get them of the bank

The bank can make $9m worth of loans (actually the bank can make any amount of loans, maybe even more), and some proportion of that may be transferred to other banks as reserves, and some other reserves will be transferred onto the banks balance sheet from unrelated transactions the bank makes. Then at the end of the day if the bank needs more reserves, it borrows them. The likely amount the bank needs to borrow based on the loans it makes and the cost of that reserve borrowing determines how many loans it will make. If it wouldn’t be profitable to make more, it’ll stop.

At no point does the bank only make 900k of loans so that it is fully covered in case all its loans are transferred out. The whole thesis of the paper is that that way of thinking is backwards.

Re: Money creation in the modern economy (2014) [pdf]

#102

Post by [deleted] »

luca3v wrote: post #37
andrepd wrote: post #16

Earlier quoted context omitted.

So this begs the question: how come private banks can do this (create money + a matching liability, that is, with no interest), but private individuals can't? Why can't I, if I want to buy a car, not simply give myself 20,000€ cash and register a 20,000€ liability, which I will pay back in due course? The bank creates zero-cost virtual cash and then earns interest by loaning it as if it was real! This is already ques…

This is not exactly how fractional reserve banking works. I think that there is a misconception that if, for example, there is a bank regulation that allows 10% fractional reserve banking, then if a bank has $1 million in deposits (of actual cash that people gave to the bank to put in their checking accounts) the bank can make $10 million in loans, with $9 million being "created out of thin hair". In fact, if a bank…

[deleted]

Re: Money creation in the modern economy (2014) [pdf]

#103

Post by iso1210 »

kgwgk wrote: post #82
louloulou wrote: post #81

Earlier quoted context omitted.

>through deposits or other liabilities This is entirely the point. The money created goes back to the bank as deposits and new money is created on top of this. i.e. 0.9^0+0.9^1+0.9^2+0.9^3+... = 10

The money created doesn’t necessarily go back to the bank. When you take a loan you use the money for something, not to keep it in an account at that bank. It will typically end in another bank. Then the bank that gave you those $900k still has just $1m in reserves and cannot lend anymore. Unless it gets some deposits or additional funding from another bank (maybe the one where those $900k ended). It seems we all agr…

> The money created doesn’t necessarily go back to the bank

Very little will be kept in a matress or burnt. Almost all will go back to a bank.

$1m in Bank A

$1m in bank B

Charlie borrows $900k from Bank B, gives to Dave, puts into Bank A

Eric borrows $900k from Bank A, gives to Felicity, who puts it in bank B.

Re: Money creation in the modern economy (2014) [pdf]

#104

Post by kgwgk »

ubercow13 wrote: post #101
kgwgk wrote: post #97

Earlier quoted context omitted.

> My only point was individual banks, can lend up to whatever the reserve requirement is. If it was 10%, $1M in reserves at the central bank means the bank can could make $10M worth of loans. Do we disagree on this point? I agree that bank can lend up to whatever the reserve requirement is. But the next sentence is extremely misleading at best. For that bank with $1m in deposits and $1m in reserves before any lending…

>the bank can make $9m worth of loans provided that the recipients of the loans never get them of the bank The bank can make $9m worth of loans (actually the bank can make any amount of loans, maybe even more), and some proportion of that may be transferred to other banks as reserves, and some other reserves will be transferred onto the banks balance sheet from unrelated transactions the bank makes. Then at the end o…

Then you could just as well say that it can make $9m in loans, $99m in loans or $999m in loans as long as enough reserves are transferred onto the banks balance sheet from unrelated transactions the bank makes (including borrowing if required).

The amount of reserves can (and will) go up and down for an individual bank as it operates depending on their strategy.

10x the initial reserves has no particular meaning for an individual bank, only for the whole system (and the whole thesis of the paper is that even then the 10x number doesn't really matter).

Re: Money creation in the modern economy (2014) [pdf]

#105

Post by kgwgk »

iso1210 wrote: post #103
kgwgk wrote: post #82

Earlier quoted context omitted.

The money created doesn’t necessarily go back to the bank. When you take a loan you use the money for something, not to keep it in an account at that bank. It will typically end in another bank. Then the bank that gave you those $900k still has just $1m in reserves and cannot lend anymore. Unless it gets some deposits or additional funding from another bank (maybe the one where those $900k ended). It seems we all agr…

> The money created doesn’t necessarily go back to the bank Very little will be kept in a matress or burnt. Almost all will go back to a bank. $1m in Bank A $1m in bank B Charlie borrows $900k from Bank B, gives to Dave, puts into Bank A Eric borrows $900k from Bank A, gives to Felicity, who puts it in bank B.

"A bank" is not the same as "the bank".

In your example, the money borrowed by Charlie from B does later go back to bank B.

But if you remove the last transaction it doesn't.

Hence, it doesn't necessarily happen.

Re: Money creation in the modern economy (2014) [pdf]

#106

Post by iso1210 »

kgwgk wrote: post #105
iso1210 wrote: post #103

Earlier quoted context omitted.

> The money created doesn’t necessarily go back to the bank Very little will be kept in a matress or burnt. Almost all will go back to a bank. $1m in Bank A $1m in bank B Charlie borrows $900k from Bank B, gives to Dave, puts into Bank A Eric borrows $900k from Bank A, gives to Felicity, who puts it in bank B.

"A bank" is not the same as "the bank". In your example, the money borrowed by Charlie from B does later go back to bank B. But if you remove the last transaction it doesn't. Hence, it doesn't necessarily happen.

Bank A $0 deposit

Bank B $1m deposit

Total deposits: $1m

Fred borrows $900k from Bank B and gives to Geraldine who puts it in Bank A

Bank A $900k deposit with no loan

Bank B $1m deposit with 900k loan (90%)

Total deposits $1.9m (90% above initial deposits)

Henry borrows 800k from Bank A and gives to Iris who puts it into Bank A

Bank A $1.7m with 800k loans (loans at 60%)

Bank B $1m deposit (loans at 90%)

Total deposits $2.7m (170% above initial deposits)

And the cycle continues, doesn't matter how many banks.

Re: Money creation in the modern economy (2014) [pdf]

#107

Post by [deleted] »

iso1210 wrote: post #106
kgwgk wrote: post #105

Earlier quoted context omitted.

"A bank" is not the same as "the bank". In your example, the money borrowed by Charlie from B does later go back to bank B. But if you remove the last transaction it doesn't. Hence, it doesn't necessarily happen.

Bank A $0 deposit Bank B $1m deposit Total deposits: $1m Fred borrows $900k from Bank B and gives to Geraldine who puts it in Bank A Bank A $900k deposit with no loan Bank B $1m deposit with 900k loan (90%) Total deposits $1.9m (90% above initial deposits) Henry borrows 800k from Bank A and gives to Iris who puts it into Bank A Bank A $1.7m with 800k loans (loans at 60%) Bank B $1m deposit (loans at 90%) Total deposi…

[deleted]

Re: Money creation in the modern economy (2014) [pdf]

#108

Post by kgwgk »

iso1210 wrote: post #106
kgwgk wrote: post #105

Earlier quoted context omitted.

"A bank" is not the same as "the bank". In your example, the money borrowed by Charlie from B does later go back to bank B. But if you remove the last transaction it doesn't. Hence, it doesn't necessarily happen.

Bank A $0 deposit Bank B $1m deposit Total deposits: $1m Fred borrows $900k from Bank B and gives to Geraldine who puts it in Bank A Bank A $900k deposit with no loan Bank B $1m deposit with 900k loan (90%) Total deposits $1.9m (90% above initial deposits) Henry borrows 800k from Bank A and gives to Iris who puts it into Bank A Bank A $1.7m with 800k loans (loans at 60%) Bank B $1m deposit (loans at 90%) Total deposi…

There is no cycle for bank B there.

It went from

  Bank B $1m deposit
  [$100k required reserves + $900k excess reserves]
to

  Bank B $1m deposit with 900k loan (90%)
  [$100k required reserves + zero excess reserves]
and it's still there at the end. It doesn't have excess reserves, it cannot make new loans if it cannot get more money.

To be clear, my original comment was: "The money created doesn’t necessarily go back to the bank. When you take a loan you use the money for something, not to keep it in an account at that bank. It will typically end in another bank."

The bank =/= A bank

One bank =/= The banking system

[Of course when another bank gets more reserves it increases their capacity to extend new loans. The question was whether a bank with $1m in deposits can lend $9m, not whether the whole banking system could.]

Re: Money creation in the modern economy (2014) [pdf]

#109

Post by ubercow13 »

kgwgk wrote: post #104
ubercow13 wrote: post #101

Earlier quoted context omitted.

>the bank can make $9m worth of loans provided that the recipients of the loans never get them of the bank The bank can make $9m worth of loans (actually the bank can make any amount of loans, maybe even more), and some proportion of that may be transferred to other banks as reserves, and some other reserves will be transferred onto the banks balance sheet from unrelated transactions the bank makes. Then at the end o…

Then you could just as well say that it can make $9m in loans, $99m in loans or $999m in loans as long as enough reserves are transferred onto the banks balance sheet from unrelated transactions the bank makes (including borrowing if required). The amount of reserves can (and will) go up and down for an individual bank as it operates depending on their strategy. 10x the initial reserves has no particular meaning for…

Yes, couldn’t you say that?

To go back to your previous point

> For that bank with $1m in deposits and $1m in reserves before any lending that 10% requirement means that it can not let its reserves go below 100k (10% times $1m in deposits) so it can only lend up to $900k out

This just doesn’t make any sense. The whole point of the reserve requirement is to guard against the risk that depositors will withdraw enough money at once to deplete the reserves. The bank needs to meet the reserve requirement of deposits on its balance sheet, not a theoretical future balance sheet. You’re explaining it as if the reserve requirement applies after the theoretical worst possible bank run occurs.

Say the debtor moves all their money to another bank as per your example. Now the bank has 1m deposits and 100k reserves. Now those other depositors also move 100k to another bank, so the bank has no reserves. Uh oh - making that 900k loan actually allowed the banks reserves to drop below the requirement in this theoretical eventuality!

Does that mean the bank shouldn’t have made the loan? No, because the reserve requirement applies to their current balance sheet. When the bank had 1m deposits and 1m reserves, it could make 9m loans. At this point it has 10% reserved (designed to guard against the eventuality that those debtors all withdraw their money). If the bank makes 900k loans and they are withdrawn, it has 1m deposits and 0.1m reserves. It is now in exactly the same situation as the previous example (scaled down). The bank doesn’t need to wait for this unlikely event to happen to allow its reserves to drop to 10%, it can just make the extra loans in the first place.

Re: Money creation in the modern economy (2014) [pdf]

#110

Post by kgwgk »

ubercow13 wrote: post #109
kgwgk wrote: post #104

Earlier quoted context omitted.

Then you could just as well say that it can make $9m in loans, $99m in loans or $999m in loans as long as enough reserves are transferred onto the banks balance sheet from unrelated transactions the bank makes (including borrowing if required). The amount of reserves can (and will) go up and down for an individual bank as it operates depending on their strategy. 10x the initial reserves has no particular meaning for…

Yes, couldn’t you say that? To go back to your previous point > For that bank with $1m in deposits and $1m in reserves before any lending that 10% requirement means that it can not let its reserves go below 100k (10% times $1m in deposits) so it can only lend up to $900k out This just doesn’t make any sense. The whole point of the reserve requirement is to guard against the risk that depositors will withdraw enough m…

>> For that bank with $1m in deposits and $1m in reserves before any lending that 10% requirement means that it can not let its reserves go below 100k

> This just doesn’t make any sense. The whole point of the reserve requirement is to guard against the risk that depositors will withdraw enough money at once to deplete the reserves. The bank needs to meet the reserve requirement of deposits on its balance sheet, not a theoretical future balance sheet.

What part doesn't make sense precisely?

A) The bank has $1m in deposits

B) It has to meet the reserve requirement (10%) for the deposits in its balance sheet ($1m)

C) The reserve requirement is $100k

D) The rest are excess reserves

The balance sheet looks like this:

    Assets                      Liabilities
    $100k Required reserves     $1m Deposits
    $900k Excess reserves
> Say the debtor moves all their money to another bank as per your example. Now the bank has 1m deposits and 100k reserves.

Sure, this is the balance sheet now:

    Assets                      Liabilities
    $100k Required reserves     $1m Deposits
    $900k Loans
> Now those other depositors also move 100k to another bank, so the bank has no reserves. Uh oh - making that 900k loan actually allowed the banks reserves to drop below the requirement in this theoretical eventuality!

That's the whole point of fractional reserve! You have enough reserves to cover a fraction of the deposits amount. If the bank has no excess reserves it will be in breach as soon as some depositor decides to get some of their money back and it will need to get more reserves to remain in compliance.

> The bank doesn’t need to wait for this unlikely event to happen to allow its reserves to drop to 10%, it can just make the extra loans in the first place.

The unlikely event that the people who take loans sends the money elsewhere? What would be unlikely is that they didn't.

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