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Money creation in the modern economy (2014) [pdf] (bankofengland.co.uk)
76 points by porterde 10 days ago | hide | past | favorite | 114 comments





From the conclusion:

> This article has discussed how money is created in the modern economy. Most of the money in circulation is created, not by the printing presses of the Bank of England, but by the commercial banks themselves: banks create money whenever they lend to someone in the economy or buy an asset from consumers. And in contrast to descriptions found in some textbooks, the Bank of England does not directly control the quantity of either base or broad money. The Bank of England is nevertheless still able to influence the amount of money in the economy. It does so in normal times by setting monetary policy — through the interest rate that it pays on reserves held by commercial banks with the Bank of England. More recently, though, with Bank Rate constrained by the effective lower bound, the Bank of England’s asset purchase programme has sought to raise the quantity of broad money in circulation. This in turn affects the prices and quantities of a range of assets in the economy, including money.

The discussion seems incomplete without mentioning government deficit spending. This is, after all, the premise of Modern Monetary Theory: that unlike households, currency issuers like the US federal government aren't under the same balanced budget constraints as households. Currency issuers can create money by spending it into being.

Budget deficits can be financed through the issuance of bonds, which look a lot like loans. But they can also be financed by just printing the money. The end result is the same, money into the pockets of people, but the implications are very different.

The MMT perspective is gaining ground, especially as the world's governments find it increasingly difficult to avoid deficit spending. A leading proponent (Kelton) proposes ditching deficit targets altogether in favor of inflation targets.


> Budget deficits can be financed through the issuance of bonds, which look a lot like loans. But they can also be financed by just printing the money. The end result is the same, money into the pockets of people, but the implications are very different.

Actually, its worse than that. The treasuries are created, sold to bank and the bank immediately sells it to the Fed for cash for a nice little profit (at least in the US)

From the Fed:

> The Federal Reserve purchases Treasury securities held by the public through a competitive bidding process. The Federal Reserve does not purchase new Treasury securities directly from the U.S. Treasury, and Federal Reserve purchases of Treasury securities from the public are not a means of financing the federal deficit.

https://www.federalreserve.gov/faqs/how-does-the-federal-res...


Kelton has a whole chapter on this in her book The Deficit Myth.

https://www.amazon.com/Deficit-Myth-Monetary-Peoples-Economy...


This is true but misleading because it represents a narrow aspect of what is going on. The Fed owns a small share of public debt. Social Securities, other Funds, and foreign actors own the bulk of it.

There's some very worthy reality in what you're speaking of, but it needs to be contextualized.


1) The other 'missing giant' is credit. Credit is a couple of orders bigger than currency in circulation and it's really what makes the world go around. We probably should start talking about credit when we talk about currency.

2) " especially as the world's governments find it increasingly difficult to avoid deficit spending" - this has always been the case.

a) Raise taxes, b) Raise debt c) Print money.

Option 'c' is generally not on the table.

And so 'Governments' are 'constrained' by the realities of economics, which is kind of what we want them to be constrained by.

It's worth noting the pretty scary nature of MMT proposals, which 'from a different perspective' amount to 'very loose monetary policy bordering on printing money to pay for stuff' and irrespective of the underlying theoretical ideals of MMT, the practical reality is that the money printing press is the 'Absolute Power' that can hardly not corrupt anyone with the power to use it, even under the cover of some intellectually grounded idea.

All government fights are, at the end of the day, really about money, the rest is mostly a distraction. It's a giant war over budgets and spending, it always is.

To give one party the magical power to do as they please without severe constraints is scary. It's even scary what we have today with the Fed (I think QE and artificially low rates to bail out home owners is really bad). I have much less faith in politicians.

I believe for MMT to work, it has to have a framework around it even more rigid than the rules we apply to Central Banks because if there's a gap that can be exploited, it will be.


I'm curious how we'll clear the hurdle of instrumenting the economy enough to meaningfully measure inflation. This seems to be the big hold up with proponents of MMT, nobody wants to guess anymore.

> This is, after all, the premise of Modern Monetary Theory: that unlike households, currency issuers like the US federal government aren't under the same balanced budget constraints as households. Currency issuers can create money by spending it into being.

It's central to MMT, but it's really just a factual observation, and the theory about it is orthodox Keynesian economics.

It's the Chicago School types that have to constantly come up with magical tripwires that deficits supposedly cause.


The central bank is the part of the government that can issue money, and it's included in the explanation.

With regard to its effect on the money supply, the rest of the government is no different than any other borrower since it can't (or at least doesn't) directly issue currency.


Cogent take.

Waiting for the crypto crowd to come in screaming about inflation or the like.


In today's environment it seems more apt to say stagflation. I'm sure there is a coin for that.

Key subquote:

> More recently, though, with Bank Rate constrained by the effective lower bound, the Bank of England’s asset purchase programme has sought to raise the quantity of broad money in circulation.

In other words: "The interest rates are already at the bottom, but we need them to be lower, so we are going to make them effectively negative through QE".

The end result: the financial sector will eventually pop and flood the rest of the economy with endless amounts of worthless money, i.e. massive inflation.


I was predicting hyperinflation from 2008 and for years after, but the evidence just isn't there.

Maybe things will eventually pop. The actual happenings of the economy (people buying and selling) are insulated from financial markets enough that a huge rally can happen without affecting lived reality for people. Maybe a pop in the financial sector can happen without actually affecting the economy? I don't see why the fed can't just make that money go away if it really needs to.


"but the evidence just isn't there."

1) The average home price in Canada increased in value more than the average workers income.

Just digest that for a second: buying a home and doing nothing, is 'more productive' than literally working.

That's a devastating situation to be in.

2) Equities are valued quite highly.

3) Esp. after COVID we are now starting to see very real inflation, we're not sure how much of it is from COVID etc.

4) There's a labour shortage, partly due to workers getting support from gov. (at least in Canada) - but a huge signal of inflation.

I believe we are seeing considerable inflation of every kind except the narrow version that the economists traditionally like to use.

Things don't have to 'pop' they can just realign slow or fast, but I believe they are realigning in ways that are going to be difficult to recover from without significant change.

If you think 'raising taxes on the rich' is a controversial idea, how about 'putting a damper on home increases'.

It's the most politically toxic thing imaginable, because it's not like those 'narrow issues' like 'gun control' that hit a narrow group with an ideology - it hits the entire middle and upper class in the pocket book.

Home affordability is a fairly existential issue, and right now in Canada there's an election and not much talking about it because it's a 'no win' for most of the parties, even if they do have some policy things in the background.

So we're already in a 'Funny Money' situation thanks to Toxic Assets from 2008 on the Fed Balance sheet, QE after that, and then 'Wartime Level Debt Spending' as a result of COVID.

It's an odd time.


Completely agree with everything you've said.

I think I've divorced housing prices from the concept of inflation because I spend so much time thinking about the underlying causes (zoning, NIMBY's, environmental reviews, etc). But the crazy price increases are enabled by the financial sector and all the money lying around.

It seems the more financialized the sector (housing, higher Ed) the worse the inflation is.

I don't know that my thinking on the boundary between finance-driven inflation and fundamentals-driven inflation is as clear as it should be.


I would like to point out that in order to put the economy into hyperinflation (50% month to month inflation), it would require the Fed to print and parachute somewhere between 50 and 200 trillion dollars in one year.

It's not very likely to happen.


[citation needed]

There's 6 trillion M0 USD in circulation, and 20 trillion in M2.

Hyperinflation is defined as ~50% monthly inflation. This means that the value of money drops ~100 fold in a year. You tell me - how much money will the fed have to print, in order to hit that target, and where would it need to parachute it?


You don’t understand hyperinflation if you think you can print your way into it. Hyperinflation has only ever occurred due to real problems in the country, a total breakdown of normal operation.

Believe it or not, Beijing propped up the global financial system in the immediate wake of 2008 by pledging to spend trillions on infrastructure, including $568B in the short term [1]. Beijing also accelerated purchases of US treasuries during this crisis, with their holdings reaching a peak (over $1T total) in 2013. These surges of spending from China aligned with the burst of asset purchases (~$1T) by the US Fed.

Needless to say, this is not going to happen again. China is no longer interested in propping up the USD. Instead, it is rapidly insulating its economy from toxic USD financialization, from its "dual circulation" domestic policy to its successful launching of the largest "USD-free" trade agreement ever in Nov 2020 [2].

2008 was already a crisis that could not be managed without global cooperation. By the numbers, 2020-2021 is far worse. The $3T surge of Fed asset purchases in 2020 has been extended by ~$1.5T in regular QE policy, with no end in sight. And there is no mega economy across the ocean that is going to sacrifice itself for the USD. There's a reason George Soros, champion of neoliberalism, is having an op-ed driven public meltdown this week.

Best case scenario, the global elite are conspiring to let the global USD have a nice gentle death and we won't even notice. Otherwise, we are looking at a massive crash and inflation.

Do you really think this monstrosity (https://fred.stlouisfed.org/graph/?g=GFV3) can continue forever?

[1] - https://www.nytimes.com/2008/11/10/world/asia/10iht-10china....

[2] - https://en.wikipedia.org/wiki/Regional_Comprehensive_Economi...

[3] - https://fred.stlouisfed.org/graph/?g=GFV3


Some of the content is in this short video: https://www.youtube.com/watch?v=CvRAqR2pAgw

Money is created by both the central bank and retail banks.

When the Bank of England buys an asset, it pays in newly-created pounds. These pounds are an obligation of the central bank, i.e. a debt owed by the bank. So these pounds are 'central bank money'.

When a commercial or retail bank gives you a loan, you have two accounts at the bank that move in opposite directions:

- current account is credited by $X (bank owes you money)

- loan account is debited by $X (you owe the bank)

So the net effect is zero (the sum of all your balances with the bank is still the same as before the loan was made). But now there's more money in your current account, so there's more money available for you to spend. Money has been created.

Even though this new money isn't central bank money:

- it's denominated in the same units as central bank money (pounds)

- it's almost as safe from default (it's protected by a deposit guarantee scheme)

- you can use it to pay for things (bank transfers are widely accepted as a means of payment)

In practice, there are capital adequacy requirements that limit how much banks can lend. They are required to keep a buffer between assets and liabilities (equity capital). As the bank's balance sheet gets bigger, more equity capital is required.


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 questionable ethically, but the fact that they can do it but I can't, I have to pay the tithe to them... That's just wrong.

Correct me if I'm missing something :)


Both you and the bank can create liabilities and use it to buy assets. The difference is the bank’s liabilities (e.g. deposits in a checking account) are generally viewed as interchangeable with money. Whereas Steve’s personal IOUs are not.

This all comes down to how safe and liquid people view the liabilities. Steve’s IOUs are at substantially higher risk of default than the banks checking account. There’s also not an easy or liquid market or facility for easily converting those IOUs to other money assets. Whereas with a checking account, I can just go to the ATM or send a wire transfer to another bank. With instruments like money market funds, I can easily sell the assets at the push of a button.

To a certain extent this is because the central bank guarantees the safety of the bank. Any gaps in a Wells Fargo checking account would just be made up by the Fed making the account holders whole with newly printed dollars.

But even absent that guarantee, the senior liabilities and term deposits of banks are considered pretty damn money like. That’s largely because banks as institutions bend over backwards to be as conservative and trustworthy as possible when it comes to their liabilities. A bank would never do the equivalent of spending a years income on a new car.

For example Berkshire Hathaway isn’t a bank and it’s not backed by the central bank. But when they issue 30 day commercial paper, then it’s treated as essentially equivalent to money. In fact there’s probably some in your money market fund right now.


You could buy a lawn mower and keep it in your garage. Then you go and knock on the door of ten other houses on your street, and say "I've bought you a lawnmower for Christmas! You just need to keep it in my garage though, rather than your own. Come and use it whenever you like! Please put it back afterwards". And then, hey presto, you have created 10 lawnmowers out of nothing. Unless of course, there's a run on lawnmowers and two of your neighbours need to use it at the same time.

Buy a reserve lawnmower

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 has $1 million in deposits it can make only $900k in loans.

Indeed, suppose you are a bank and you have $1 mil in deposits, which you keep as reserve with the central bank. Now someone asks for a $900k loan. Now you have $1.9 mil in deposits ($1.9 mil liabilities), and you have $1 mil kept with the central bank in cash, and $900k owed from the guy with the loan (total $1.9 mil in assets, it checks out).

Now the guy with the loan withdraws his $900k to pay for his house or whatever; the bank gives him the $900k from the cash account it has at the central bank. Now the bank has $1 mil in liabilities (the checking accounts of the depositors), $100k in cash with the central bank, and $900k owed from the guy with the loan. Everything still checks out, but now the cash on hand is just $10% of the assets. The bank has reached the fractional reserve limit, and it is not allowed to make any more loans.


This is right, but then the house seller now has $0.9mm in cash. When she deposits it in her bank, that bank can make another loan but only for $0.81mm and so on and so on.

The geometric sum to infinity ends up being 1/reserve_ratio; so if that's 10% in this example, the theoretical money creation is 10x.


Yes, this is correct! But some people, and perhaps not the grandparent comment, understand the "money creation" point as that money can be replicated infinitely, that is a bank get $1 mil deposit and makes $10 mil loans, and those loans, if deposited, could lead to $100 mil loans and so on

I'd say that's creating circulation more than creating money.

If you had no bank deposits at all, and nobody ever saved money, saving is outlawed, you gotta spend it, you'd have 1M in total cash in the economy. It would be moving around a bunch, but if you froze the system and counted it, there's 1M available to be spent at any moment in time. Let's compare to 1M deposited in a bank. 900K of it is circulated to the house seller, etc... The total amount circulated follows the geometric sum.

But, if you freeze the system at any moment in time, there is NOT a geometric sum of money in cash or other places immediately available to be spent! Most of this is going to be in accounts with daily withdrawal limits, for instance. We're messing with time here much more than we're creating money - it's a bit of a magic trick, yes, but one that's based on "not everyone is going to want to move all their deposits at the same time, let's take advantage of that to make the system more efficient, at some risk of stability." Not based on infinitely printing money at retail banks. And the risk has, in the better part of the last century, been fine - it's distributed, it's insured, etc. We could have a big discussion about if it's gonna be ok for ever, but first, that's different from this claim of "banks have special privileges to create money that I wish I had."

And the bank still needs to make sure their loans were sensible and low-enough-risk - things have to balance up in the end as people do make various withdrawals at various points in time - and many of those loans also go into accounts at other institutions.

In a world without this sort of banking, you'd still have loans backed by other things, like interest and payment income, like credit cards, but not ones tied at all to deposits - and it should be pretty clear that credit card companies aren't printing money, they're just shuffling it around.


>and it is not allowed to make any more loans.

No. From the paper

>In reality, neither are reserves a binding constraint on lending, nor does the central bank fix the amount of reserves that are available.


That's just randomly quoting sentences out of context. What you quoted is from the standpoint of a particular central bank, not from the standpoint of an arbitrary lending bank. Absolutely, many lending banks have reserve requirements imposed upon them, just not in the particular country of this paper!

In most counties in the west, reserve requirements don't constrain lending. For example, Canada, the UK, and Australia have a reserve requirement of zero. Fractional reserve banking doesn't really exist anymore outside of economics textbooks.

Capital requirements are what constrain lending in the west (I think the Chinese government does try to control lending in part via a reserve requirement). For example, the "Core Tier 1 Capital Ratio" [0] is extremely important in this regard.

https://www.investopedia.com/terms/t/tier-1-capital-ratio.as...


The United States has reserve requirements. The EU has reserve requirements. India has reserve requirements.

I never claimed they didn't. I claimed the reserve requirements didn't constrain lending.

Well yes, this article is about the UK. But the paper is quite clear that in practice, it is not any reserve requirement that effectively determines how many loans a bank will create. I am guessing this applies equally to other modern economies even if they have such a limit?

It's one sentence but the context is that the whole paper is arguing against the textbook explanation of fractional reserve banking GP stated - the "two common misconceptions" stated in the introduction.


> it is not any reserve requirement that effectively determines how many loans a bank will create

But according to that article it may be, because that bank will need to increase reserves to expand lending and acquiring them has a cost.

“But that does not mean that any given individual bank can freely lend and create money without limit. That is because banks have to be able to lend profitably in a competitive market, [……] whether through deposits or other liabilities, the bank would need to make sure it was attracting and retaining some kind of funds in order to keep expanding lending. And the cost of that needs to be measured against the interest the bank expects to earn on the loans it is making,“


You should read the article, because it seems you're the one with the misconception.

how it works -> "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"

not how it works -> "if a bank has $1 million in deposits it can make only $900k in loans"


What the article says is that to lend out more than $900k it has to increase it reserves (maybe borrowing from other banks). Not that it can lend out $10m with just $1m in deposits.

“By attracting new deposits, the bank can increase its lending without running down its reserves, as shown in the third row of Figure 2. Alternatively, a bank can borrow from other banks or attract other forms of liabilities, at least temporarily. But whether through deposits or other liabilities, the bank would need to make sure it was attracting and retaining some kind of funds in order to keep expanding lending.”


>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 agree that “if a bank has $1 million in deposits it can make only $900k in loans.” In the aggregate banking system there are now $900k more, some bank may use the reserves created by that deposit to lend $810k, etc.

That’s not the same as

how it works -> "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"

which is wrong.


I'm afraid you're simply wrong and need to do some more research. There's no magical point in time where money is "in use". It is always credited to someone's bank account at any given point in time.

The baking system as a whole is leveraged about 9:1 based on the previous example. A bank deposit is a bank deposit, regardless of which bank it is at.


You didn’t say

"if the banking system as a whole has $1 million in deposits (of actual cash that people gave to the bank to put in their checking accounts) the system banking as a whole can make $10 million in loans" [and there will be in the end $11m in deposits in the banking system as a whole, offsetting the $1m in reserves and $10m in loans]

You said

"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" [which is wrong unless you assume that every loan remains in that bank as a deposit so the “banking system as a whole” case is recovered]

Of course that bank could get more reserves to be able to make additional loans. But then it could lend much more than $10m if it gets enough deposits/reserves! [One bank =/= The banking system as a whole]

Edit: by the way, I’m curious what is the thing in my previous comment that you find “simply wrong”.


I mean apologies if I'm misunderstanding what you're saying - but as far as I can tell you're claiming the leverage ratio for a bank is 0.9:1 and I'm saying it is 9:1. If that's the case only one of us can be correct.

It doesn't help that you're conflating the terms "deposits" and "reserves". Deposits are liabilities of the bank, while reserves are assets held in their account at the central bank.

If the banking system as a whole is leveraged 9:1, that implies each individual bank is leveraged approximately 9:1.


https://www.investopedia.com/terms/r/requiredreserves.asp

"Reserve Requirement Example As an example, assume a bank had $200 million in deposits and is required to hold 10%. The bank is now allowed to lend out $180 million, which drastically increases bank credit. In addition to providing a buffer against bank runs and a layer of liquidity, reserve requirements are also used as a monetary tool by the Federal Reserve. By increasing the reserve requirement, the Federal Reserve is essentially taking money out of the money supply and increasing the cost of credit. Lowering the reserve requirement pumps money into the economy by giving banks excess reserves, which promotes the expansion of bank credit and lowers rates."


What I’m saying is that if you create a bank and I make a $1m deposit [0] your bank has

  Liabilities : deposit $1m
  Assets : reserves $1m
Now you can lend $900k to someone, who takes the money and tranfers it to someone else’s account in another bank to buy bitcoins or whatever. Your bank has now

  Liabilities : deposit $1m
  Assets : reserves $100k, loan $900k
And you cannot make more loans until you increase your reserves which means getting new deposits (so we’re no longer talking about a bank with $1m in deposits).

Say you get an additional million in deposits, your bank has now

  Liabilities : deposits $2m
  Assets : reserves $1.1m, loan $900k
And it could lend and additional $900k.

Alternatively, it could get funding from another source like borrowing from banks of issuing bonds. For example

  Liabilities : deposit $1m, bond $1m
  Assets : reserves $1.1m, loan $900k
I don’t think any of this is controversial, let alone wrong. By the way, for simplicity in those balanced sheets the “reserves” is all the funding available which has not been lent, not just the required reserves ($100k for $1m in deposits, etc.)

> If the banking system as a whole is leveraged 9:1, that implies each individual bank is leveraged approximately 9:1.

One of the main points of the paper under discussion is that this doesn’t happen. Reserves are not a binding constraint on lending.

[0] I don’t know if it makes much sense to talk about whether it is “actual cash”. Maybe my employer took a loan to pay me, maybe not. Maybe it was in cash, maybe by cheque, maybe by bank transfer. Would that change anything?


That's no different than what I said, except you're conflating the ledger money created by banks with their reserves at the Central Bank.

Only Central Bank reserves and cash are considered "money" in this system. And I'm saying the "money" is leveraged 9:1 in our toy example, whereas you seem to be saying assets must always be greater than liabilities - which obviously I agree with. Since if they weren't, the bank would be insolvent.


You said

"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"

What I say is that it can only make more that $900k in loans _if_ the deposits held at the bank grow above $1m. Which doesn’t normally happen when lending because the most likely outcome is that the borrower takes the money out of the bank.

The reserves of the bank go down in that case, don’t you agree? They are just $100k after the $900k loan is made (and transferred away). $100k are the minimal reserves required when a bank has $1m in deposits.

Again, an individual bank is not the same as the banking system as a whole.

And I don’t quite get your remark about reserves. What I called “reserves” could be entirely held at the central bank (or in the vaults!) if the bank wanted to. Do you have an issue with those balance sheets?


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. Do we disagree on this point?

It seems like we're arguing about what is actually money.


> 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 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.

I can agree if you say "the bank can make $9m worth of loans provided that the recipients of the loans never get them of the bank [and it ends with $10m in deposits]". That is reasonable (even approximatively true) for the banking system as a whole but is a ridiculous implicit assumption for an individual bank.

I would also agree if you said "a bank with $10m in deposits needs to have at least $1m in reserves".


>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.


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).


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.


>> 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.


> That's the whole point of fractional reserve! You have enough reserves to cover a fraction of the deposits amount.

Yes exactly, by making 9m loans, the bank has a fraction (10%) of reserves to cover the deposit amount (10m).

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

You are assuming that 100% of deposits created by loans will be immediately withdrawn. The thing that doesn’t make sense is that you’re treating deposits created from debt as special. The bank needs reserves of 10% of all its deposits.

Why are you considering the eventuality that the loan holder buys something but not that the saver buys something? They are both equally irrelevant as they are eventualities factored into the 10% requirement.

Say there is only one current account holder at the bank with 1m savings. Then the bank gives that customer a 900k loan. Now the customer buys a house. Why do you assume the house will cost 900k? They might buy a 1.2m house, in which case the bank is stuffed, as it only has 1m reserves. There is nothing special about the 900k.


> Why are you considering the eventuality that the loan holder buys something but not that the saver buys something?

Because people take loans for something? It could be to invest, definitely not to keep it untouched in a current account.

Do you know of a single case of someone who took a loan for the sake of it, leaving the deposit created untouched at the lending bank, and paying interests for the privilege of having that deposit?

(The eventuality that the saver buys something is why banks keep reserves, with minimums set by regulators in some countries. To allow for a fraction of those depositors to buy something without the whole setup collapsing immediately.)

Edit: and for what it's worth, this "eventuality" is also seen as a basic scenario in the paper under discussion. That's what Figure 2 is about:

"The house buyer takes out a mortgage... ...and uses its new deposits to pay the house seller."

"The mortgage lender creates new deposits... ...which are transferred to the seller’s bank, along with reserves, which the buyer’s bank uses to settle the transaction. But settling all transactions in this way would be unsustainable: [...] the buyer’s bank will in practice seek to attract or retain new deposits (and reserves) [...] to accompany their new loans."


> couldn’t you say that?

Ok, then this is NOT how it works -> "if a bank has $1 million in deposits the bank can make $10 million in loans"

I can agree with either of the following formulations:

"if a bank has $1 million in deposits the bank can make $10 million in loans as long as the loans remain as deposits in the bank"

"if a bank has $1 million in deposits the bank can make loans for any amount that it wants as long is it can comply with the reserve requirements"


Yes then I think we’re in agreement and just talking around in circles! It seems the second statement is most meaningful in relation to how banks actually operate (based on my understanding of the paper). The example where 9m loans are made and none transferred out, and the example where 900k loans are made and 100% are transferred out are both extremes.

Referring to that 10% reserve requirement, understand that the is on DEPOSITs. The bank must retain 10% of it's deposits and can loan out 90% of it's deposits. When the bank makes a loan, that money becomes a deposit at another bank, for instance, the bank gives me a loan to purchase a car. That money goes to the person I have bought the car from and that person then deposits it in their bank. The bank they deposit it at could be the same bank I took my loan out from or it could be another bank. It depends on who I bought my car from. That deposit increases the total DEPOSITs at the bank where it is deposited. In the larger scheme of things, I am not the only person taking out loans and buying cars. So, in the greater scheme of things, while my borrowed money becomes a deposit in another bank, someone else borrowed money at another bank and deposited it at my bank. But a deposit is still a deposit, whether it is from a loan at the same bank or a loan from another bank. It doesn't matter. In theory, a bank could be getting all of the loans it makes back as deposits. That doesn't happen, though I question what happens when you buy a car from a Ford dealership and get a loan from Ford Financing. Regardless at no time has the bank ever made loans in excess of it's total deposits. The net result is that, through the magic of the money multiplier, because the banking systems deposits are increasing, iteratively, as loans become deposits, become loans, that 10% reserve requirement results in a money multiplier of 10. Every loan, because it is iteratively deposited back into the banking system, results in ten times as much money in deposits as there are in loans. So, lets see how that works. Bank 1 has $10 and loans out $9. (We will ignore where that initial $10 comes from for now). That $9 is deposited into bank 2 and now Bank 2 can loan out .9 * $9 or $8.10. That gets deposited into bank 3 that can now loan out .9*$8.1. If I remember my math from my economics studies, that becomes $100 in loans when all the bank loans are added up. $10 in an initial deposit becomes $100 in the money supply. But this does not mean that each individual bank is leveraged 9:1. No bank has loaned out 10 times it's deposits. It always has more deposits on account than it has outstanding loans. And keep in mind, it's loans are an asset. Deposits are a liability. Someone owes money to the bank when it makes a loan. The bank owes money to someone else, when they make a deposit. Because it has 10% of deposits on reserve, it always has 10% more assets than liabilities. Now, I don't know what you mean by "leveraged" 9:1, but if you mean that it has more liabilities than assets, this is not correct. If you are thinking that deposits are assets, then while I do get what you are thinking, they aren't. The deposits don't belong to the bank. It doesn't own that money. It has it on account, but it doesn't own it. Someone loans the bank money, the bank loans out the money it borrowed. It pays .01% on deposits, it charges 10% on it's loans.

Do, by all means, double check this. It's been quite a while since my studies so I had to work this out on the fly. I am generally more comfortable researching what I think I know then going over it again, and again, and again...... But I'm pretty sure that's right. It's in that deposits are liabilities and loans are assets things where, in working it through, I got that "oh!" moment.

It is an interesting thing, though. Because if you unwound all the deposits and all the loans in the economy, there would be no money in the money supply. All of it is dependent on loans and the money supply grows in response to the economy increasing. As the economy increases, there is a demand for more money. That demand results in more loans that results in an ever increasing supply of money.

It still weirds me out. But then, I do engineering, not money.


> 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.


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.]


It sounds like "creating money out of thin air" here more specifically means "increasing the amount of currency in circulation by exchanging it for liens or other obligations for payback." Not just printing money in a vaccum.

I don't think a bank without deposits would get very far issuing loans.

My understanding: The bank isn't required to hold 100% of the money you deposit in cash, though. It can lend it out up to certain limits. So if everyone tries to cash out all at once, shit will go sideways. But it's not because the money didn't exist before: the bank has a claim to a lot of assets to still attempt to balance it out in the case of collateralized loans.

If the bank wasn't there, we'd have to P2P all our lending. The bank just acts as a bigger, hopefully-more-efficient middleman, with a bunch of government regulation trying to balance out the risk/reward. If you, as an individual lender, chose the wrong person to lend to, your money would be at risk - similarly to if you choose a bank that massively fucks it up. But the deposit bank would have to fuck up way worse, under normal circumstances.


"I don't think a bank without deposits would get very far issuing loans."

When a bank issues you a loan, it creates a deposit for exactly the same amount in your account. So what you said is true, almost by definition.

But many loans are issued by entities other than banks. You can lend profitably without being a bank. (google 'nonbank lenders')


I mean that if you created a new bank, and never accepted any customer deposits, you are going to run into problems if you simply offer a bunch of loans.

If your loan customer wants cash, or wants to move some of that loaned money into another institution... whatcha gonna do?

Your nonbank credit card company would run into similar problems if they didn't have any income and simply were letting people buy products with magic printed money, but "credit cards create money out of thin air" doesn't get tossed around in the same way as it does for banks.

(Also, your claim about the deposit is entirely false for many loans. Every car loan I've had, for instance, has been either paper or electronic checks for delivery to the dealer, I've never had that money in my own deposit accounts. It goes straight to a deposit account at (usually) another institution, where it would damn well be noticed if the lending bank couldn't actually make good on the funds.)


"I mean that if you created a new bank, and never accepted any customer deposits, you are going to run into problems if you simply offer a bunch of loans."

'Deposit-taking institution' is pretty much the original definition of a bank (see 'Banking Act 1979'). But, putting that aside...

"If your loan customer wants cash, or wants to move some of that loaned money into another institution... whatcha gonna do?"

The same thing you do every night: borrow money overnight in the interbank market. If this becomes a regular thing, liquidate some assets.

"Your nonbank credit card company would run into similar problems if they didn't have any income and simply were letting people buy products with magic printed money"

When a nonbank lender grants a loan, it cannot create money in the same way that a bank can. It can't disburse the loan without having the money on hand already. By 'on hand', I mean 'in an account at a bank'. The source of that money could be:

- (equity) investors

- interest earned from other loans

- wholesale funding (money borrowed from other lenders)

- proceeds from selling loans to other parties (directly or via securitization)


> The same thing you do every night: borrow money overnight in the interbank market. If this becomes a regular thing, liquidate some assets.

You don't have any assets in the scenario we're talking about. Nobody is going to lend you money, because you're not a bank, you're a sham scheme trying to start up a magic money-printer.

You can't disburse another institution or to cash without having some assets somewhere to back all of this up. Your balance sheet, ultimately, has to make sense. Your supposed bank here couldn't loan me money to buy a car, because the dealer isn't going to be happy with numbers on a ledger in my account at this bank, they want something harder.


"You don't have any assets in the scenario we're talking about."

I'm not aware of any country that will allow you to start a bank without any assets.

I'm sorry, I don't think any explanation I give will satisfy you, so I won't comment further.


> I don't think a bank without deposits would get very far issuing loans.

Really? That's what banks do now.


When banks create money with a matching liability, they face the risk that the customer will try to take the money out in cash, or transfer it to an account at a different bank. In order to accommodate this they actually have to have the cash on hand, or borrow it from another bank with interest.

Likewise if you have 20,000€ on hand, or can borrow it from somewhere, you can use it to buy a car. You can then keep a mental note that you 'owe yourself' this money, but doing so makes no real difference.


> they face the risk that the customer will try to take the money out in cash, or transfer it to an account at a different bank

“They face the risk” seems a huge understatement. It would be quite unusual for someone to take a loan from a bank and leave the money sitting there at the bank.


Almost the entire business of a bank is to profit from maturity mismatch by borrowing short, lending long and taking the interest margin.

When banks "create money" there is a matching liability already in place -- the claim that some depositor has on that money. The bank isn't "richer" by having made that loan.

An imperfect analogy is if you buy a car for 20,000€ using a credit card. You haven't paid any real money, but now you have a liability that the credit card company will eventually claim.


"not simply give myself 20,000€ cash"

Only the ECB and national central banks can create € notes (by which I mean central bank cash money).

Nothing is stopping you from creating your own notes denominated in €, but these would be obligations (IOUs) issued by andrepd. Just like bank deposits, these notes are private money, not central bank money.

It might be tough for you to find a car dealer willing to accept these andrepd € notes, though.

"The bank creates zero-cost virtual cash"

Making loans changes banks' reserve requirements, so they're not zero-cost.


But the point is that the money they create is 100% fungible with central bank banknotes! It is passed onto the economy as cash. It does not come with a tag saying "created by Santander" or whatever.

> Making loans changes banks' reserve requirements, so they're not zero-cost.

Okay! So give me similar requirements! Asset/liability ratios, reserve requirements, cash flow requirements, the works, to determine given my finances how much liabilities I can create.



Yes, there are plenty of powers that we limit to a subset of chartered organizations. If you want to have a share in this power, you can buy ownership in a bank - a share of JP Morgan is about $160.

I disagree that it is intrinsically wrong that some people can do something that you cannot do.


You don't have to be a chartered bank to have this power.

If your neighbor lent you a hundred bucks and you loan ninety bucks of it to a different neighbor, you've done the same sort of thing. Of course, if you do it at a small scale, you're at high risk of having empty pockets if that neighbor wants their hundred back at an unexpected time. But do it to a thousand neighbors on either side of the exchange, and you can probably get away with re-lending most of it for a long time.

They aren't granted special money-making abilities; more the reverse: they are under regulations to prevent this power - which is, in happy times, very good for the economy - from being abused. We can argue about if those regulations are strong enough or not, but I think the "money is bullshit cause banks print it out of thin air" arguments are intentionally misleading from opponents of a system that otherwise isn't actually terribly complicated.


Well that's a very unsatisfactory answer. As to the 1st paragraph: what do you mean? That's not at all what I'm saying, buying shares in JPMorgan doesn't give me money creation privileges. As to the 2nd: if you restrict rights and privileges to one group of people you better have a good reason why! Just saying "it is so" is not a good reason :)

You can do this, but the car owner likely won't accept your paper as having monetary value.

Banks are regulated through the nose (in most places at most times) to make sure they don’t mess it up. The money creation is a carefully choreographed juggling act where balls can’t fall on the ground.

The extra money created is effectively money someone doesn’t need right now (deposit) that can be temporarily used, and returned eventually, by someone else. When it works, it works very well, but when it doesn’t, banks go bankrupt and someone generally loses money (deposits are insured but then the insurance scheme loses).

It’s not a bad thing overall, our capitalist world would be impossible without it, but this money creation craziness is a necessary component.


> Banks are regulated through the nose (in most places at most times) to make sure they don’t mess it up.

Eehhhhhhh........ Sounds like that isn't working out so well is it? x) With the only difference of course that if _I_ fail my obligations I don't get a taxpayer-funded bailout financed by cuts to people's salaries and pensions, instead my house gets reposessed and I go live with my kids to a homeless shelter.

But anyways. So give me similar rules: asset/liability ratios, cash flow minimums, the works!, to determine how much I can create by this mechanism.

> The extra money created is effectively money someone doesn’t need right now (deposit) that can be temporarily used, and returned eventually, by someone else.

That's not true in fractional reserve banking, and we're actually well last that, we're into no-reserve banking now.


> Eehhhhhhh........ Sounds like that isn't working out so well is it? x)

Over the past 88 years, not a single penny of FDIC-insured money has ever been lost in a bank collapse... And when a bank collapses, non-FDIC-insured money also finds a way to not evaporate. The biggest bank bust in history - Washington Mutual, with $300 billion under management collapsed in 2008. Not a penny of its depositor funds, insured or not, were lost.

Meanwhile, in the three years prior to the establishment of the FDIC, over 9000 banks collapsed, collectively losing $140 billion dollars of depositor money.

One of the most important jobs of the federal government is maintaining confidence in the banking sector, because without it, we'd all be living in a Mad Max hellscape, trading bottlecaps for ammunition.


Why do you think you COULDN'T start a bank?

(And if starting a bank was a magic money-printing machine, no bank could ever need bailing out! They could bail themselves out! By definition!)

And can you go into more of why you don't think that applies to fractional or no-reserve banking? If I'm required to hold all my deposits in cash, I'd have to fund my loans through a different mechanism. Isn't lower reserve requirements precisely the means through which "money someone doesn't need right now" can be "temporarily used, and returned eventually, by someone else"?


Yeah, we’ll, the credit crunch was an enormous fuck up. I kind of blame the regulators for letting the wolves self-regulate sheep herding, though of course it was ultimately a team effort. But that was all a textbook example of regulating banks the wrong way.

> That's not true in fractional reserve banking, and we're actually well last that, we're into no-reserve banking now.

How so? In Europe at least, banks lend from their own loans (a mix of deposits, bonds and commercial papers), plus need capital at a fraction of assets (ie loans made).


Since it’s about Bank of England and money creation, this can’t be missed: https://en.wikipedia.org/wiki/Bank_of_England_%C2%A3100,000,...

Some banks in the UK can issue their own banknotes, but these must be backed up in cash with the BoE. And it’s awkward dealing with millions in used fivers. Hence the 100 million notes and friends.

You’d think other solutions exist in the 21st century but :shrug:


Some past threads:

Money Creation in the Modern Economy - https://news.ycombinator.com/item?id=25885849 - Jan 2021 (1 comment)

Money Creation in the modern economy [pdf] - https://news.ycombinator.com/item?id=22923785 - April 2020 (1 comment)

Money Creation in the Modern Economy - https://news.ycombinator.com/item?id=20875899 - Sept 2019 (1 comment)

Money creation in the modern economy (2014) [pdf] - https://news.ycombinator.com/item?id=16604251 - March 2018 (123 comments)

Money Creation in the Modern Economy (2014) [pdf] - https://news.ycombinator.com/item?id=11374907 - March 2016 (97 comments)


I think Richard Werner's empirical research on how banks create money is probably better than anything put out by the banking system itself, including the central banks.

https://www.researchgate.net/publication/265909749_Can_Banks...

https://www.researchgate.net/publication/283907413_Do_banks_...

His work made realize that not even the banking system fully understands the banking system.

(Werner is the economist that coined the term Quantitative Easing, originally created to describe Japanese post-WWII economic re-development monetary policy, research that later informed the US Fed's response to the GFC, among other things)


I think we give far too much credence to term coiners.

I'm unsurprised to see him recommended here, as HN seems to veer heavily towards inflation trutherism, anti-central banking, and libertarianism, even if most commentators probably wouldn't share Werner's antivaxx beliefs.


It wasn't that he coined the term, but that he recognized an important phenomenon and published a description of it before anyone else, which later came to inform major decisions about the worst financial crisis since the Great Depression.

Naming that phenomenon was just a byproduct of recognizing and writing about it, and I mention it only because it implies all of the above.

And his vaxx beliefs aren't relevant to research he did prior to the COVID outbreak, but if you have a specific critique of that research I'd be interested to hear it.


I remember David Graeber mentioned this report in “Against Economics”[1]. It’s a pretty interesting read if you like reading about MMT. [1] https://theanarchistlibrary.org/library/david-graeber-agains...

The comments in this thread prove yet again that economics is a far cry from any science. Nobody really understands why this system of credit actually works as well as it does and even more troubling is what will be it's next iteration given that it's starting to crumble.

Unfortunately for most of us though it appears as though the adage that 'cash is trash' is starting to become a very real problem even in the west and necessitates that all of us transition to holding yield producing assets with risk. In other words, even grandma is an investor (aka gambler) now by force.


"Let us never forget this fundamental truth: the State has no source of money other than money which people earn themselves. If the State wishes to spend more it can do so only by borrowing your savings or by taxing you more. It is no good thinking that someone else will pay-that "someone else" is you. There is no such thing as public money; there is only taxpayers' money."

https://web.archive.org/web/20110606031420/http://www.margar...

In England, sometimes we need to explain to us where money comes from, just in case anyone forgets. :)


Though todays big question is "How do you destroy money?" ie get it back?.

You can tax and not spend but so much money has escaped abroad and hidden where you can't touch it.

There is inflation but that is a dangerous pandoras box.

Or you can say boost productivity and just create enough extra stuff to match all the extra money. Easier to say than to do though. You just have to live in hope that someone invents some wonderfully productivity enhancing something, fusion, robots or ai perhaps. Come to think of it perhaps Apple is really a government conspiracy to soak up consumers excess dollars? The Apple Tax suddenly fits hmmm.


I sometimes wonder how anything about economics can be tested when the world’s manufacturing has been outsourced to China. All of these theories rest on the fact inflation has been largely under control in the west, not because of a lack of gold standard but because almost all physical items have had zero or negative inflation for 30 years or so. All the things not “Made in China” I would say have been massively inflated. If we were to start having to produce say plumbing supplies locally (say due to Climate change) will these theoretical money creation mechanisms still work?

The US is a net exporter of food, and yet the price of food has significantly undershot headline inflation over 30 years.

Interesting! I don't know enough about the US agricultural system but I suspect technology plays a big part in that reduction in cost... I found this amazing raspberry picker for example! https://www.youtube.com/watch?v=3iXJFDoKEvI&ab_channel=OxboI...

Maybe you're right and everything would just be made with machines in the West if China wasn't cheap to source things from. But then we come back round to what do you do with the bottom half of workers...


This is a MUST READ for any adult.

Money literally runs our lives. We spend most of our waking time trying to get some.

This explains where money comes from. And it's completely different than what you are taught in school or by media and economist pundits.


This is outdated. Maybe Bank of England still operates like this?

Major central banks like US Fed, European ECB or Bank of Japan don't generate money using fractional reserve banking anymore.

They use open market operations or quantitative easing instead. In other words, they buy debt, like treasuries with money.


One implication of what the article is talking about, in fact, is that fractional reserve banking isn’t really a thing, and has only ever been an inaccurate model for how banks really work.

A large proportion of money in modern economies is generated (along with private debt) in the private banking system. It is true that central banks can also create money (and in fact can do it without creating debt, unlike private banks), and can use this money for quantitive easing, but it’s not an either or - both are happening.


I don’t think the article is outdated: US, Europe, and Japan all still use fractional reserve banking to create money. The central bank controls the base money supply using tools like open market operations or quantitative easing, but the broad money supply is some multiple of the base money supply. That multiple is determined by what fraction of deposits is lent out by commercial banks in the banking system.

The Fed actually completely eliminated the reserve requirement in March of last year (1). Unsurprisingly, this hasn't gotten a lot of attention from the corporate media.

1 - https://www.federalreserve.gov/monetarypolicy/reservereq.htm


Lots of countries have no reserve requirement. It actually doesn’t change much, just the asset mix banks hold.

How much a bank can lend is basically entirely determined by the amount of paid-up capital, not reserves anyway. The maximum ratios are fairly strictly regulated (e.g. Basel rules).


So, I'd been interpreting this change as meaning that they're no longer required to carry some minimum amount of cash.

I would be more confident in banks if they were required to carry some minimum fraction of their balances in cash in order to guarantee availability of funds.

That said, I'm re-reading the page that I linked a bit more closely and realizing that it doesn't just say "reserve requirements must be satisfied by holding vault cash" , it says "reserve requirements must be satisfied by holding vault cash and, if vault cash is insufficient, by maintaining a balance in an account at a Federal Reserve Bank".

It's not clear to me whether that "balance" at a Fed bank must be in cash, but even if it is, I'm realizing that the requirement I was hoping existed may not have existed even prior to this change.

TL;DR - Requirement for strong, local, cash reserves would be better than weaker requirements is better than no requirements. I'm not sure how close to the good end of that spectrum we've ever been, but where we are now certainly doesn't seem too good.

Note: Please do explain if there is some nuance that I'm missing here


This is the nuance you are missing:

https://fred.stlouisfed.org/series/EXCSRESNS

The reserve requirement served no purpose because banks were holding trillions of dollars in excess of their reserve requirements meaning that the reserve ratio was an ineffective monetary policy tool.


newb question what is paid up capital?

It's a combination of capital paid from shareholders holding fully paid shares (i.e. shares that were paid in full when issued - for example, when shareholders buy new shares in capital raising rounds) and retained earnings.

I'd be interested to hear why you think this is newsworthy. It's not like reserve requirements were an effective monetary policy implement for the past several years - banks have been holding hugely in excess of the required reserves for a while now.

Banks don’t lend out deposits to they create money that is then eliminated when the debt is paid back.

To create money banks need a certain amount of capital this is governed by capital requirements most of which come from the capital invested into the bank through share purchases.

Many countries have no reserve requirements at all, BOE specifically doesn’t even issue them any longer.


>Banks don’t lend out deposits

Banks do lend out deposits, which is why when they fall below capital reserves as a result, they use the overnight lending facility of the Fed [1] (or similar processes in most countries) to maintain mandatory capital reserves. It leads to data like this [2] which shows the actual amount held by banks versus deposits.

[1] https://www.newyorkfed.org/markets/reference-rates/obfr

[2] https://fred.stlouisfed.org/series/M14060USM156NNBR


Fed's reserve requirement is currently zero percent. Multiple of zero is zero.

The article doesn't talk about fractional reserve. It talks about commercial banks creating money by extending loans. It also talks about QE as another way of creating money by the central bank, when commercials banks aren't creating enough money.

That's not what quantitative easing is.

Central banks are passing private banks in their money creation.




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