Yes, they do. A dollar created by JPMorgan Chase out of a loan wires exactly the same as a dollar created by the Federal Reserve out of purchasing a Treasury. (They both look exactly the same in your bank account and withdraw exactly the same as cash.)
Money supply is fascinatingly complex [1].
The goal of the Central Bank it's to control the interest rate, not the quantity of money. If there are not enough reserves in the inter-bank market, and the Central Bank refuses to supply them, the interest rate will go up.
So, if the Central Bank want to control the interest rate, it can't control the quantity of money and vice versa.
Modern Central Banks target the interest rate, not the quantity of money. The quantity of money in the economy it's automatically regulated by the level of economic activity.
"The central bank influences interest rates by expanding or contracting the monetary base, which consists of currency in circulation and banks' reserves on deposit at the central bank"
If you don't feel that quote clarifies feel free to read the rest of the section on monetary policy instruments.
In other words, if they target the interest rate they can't control the monetary base, so, Central Banks don't control the quantity of money in the economy.
If they choose to target the quantity of money in the economy, the tool that they have to use is the interest rate. So, they would lost control over the interest rate.
Modern central banks target the interest rate: they sacrifice control over the monetary base. The central bank don't decide the quantity of money in the economy, they decide the interest rate.
The implication is that they have to cover any necessary reserves by the private banks if they want to keep the interest rate in its target. So, yes, private banks create money when they lend and destroy money when the money is returned. And that's OK because that means that the quantity of money adapts to the activity of the economy.
This is correct. (The Fed has other tools beside open market operations, however, including directly manipulating rates on reserves and the discount rate.) But monetary base != money supply. The Fed manipulates rates to effect changes on the money supply.
The feedback loop is the point, and it remains.
Yes, if the money created is in the end kept in the system as a deposit it enables new loans (but it is not necessarily so if the money goes to someone that uses it to cancel a loan of their own, for example).
And due to the fractional reserve requirement the quantity of money cannot be increased without limit by commercial banks. That’s just a mathematical reality, notwithstanding the fact that it’s not usually a binding constraint.
>> they don't have the right to print money the way a central bank does.
> Yes, they do.
The private bank is forced to search for a quantity of reserves proportional to the money it has created, but it does it a posteriori. The credit department only responsibility it's checking if loaning you money is a good business.
For really big transactions, it becomes obvious. If I borrow $1 trillion from a bank, and immediately transfer it out, the bank can't get that money a posteriori. It can't transfer more than it has. It needs to borrow the entire sum, plus the reserve cushion, from someone else - other banks, depositors, or the Fed.
To be clear, I am in no way denying that bank lending increases the money supply. The contrast I'm drawing is with the Fed itself, which really can lend $1 trillion without getting it from anyone else.
My own household experience with money and all analogies failed me when I first started thinking about these things. It only clicked once I started drawing up balance sheets.
As for the giant loan and transfer, I think that might be cleared soon-ish and only settled, with an interbank or fed loan if needed, at a later point in time after netting with other transfers.
If you move your loaned $1 trillion to another bank, your bank will have to find the reserves from other banks or from the Fed.
If it find it in other banks, no new reserves have been added, so, certainly, new money is in the system without the central bank doing nothing.
If it don't find the reserves in other banks at a good price, it will have to ask it to the Central Bank.
Now, the Central Bank have two options, it can give the reserves to the bank or it can refuse. If it refuse the private bank have to get the reserves in the inter-banks system. It have to. Otherwise it would be breaking the law.
So, it will be willing to pay anything necesary for the reserves. That will create additional demand in the reserves, and that mean that the interest rate will go up.
If the central bank wants to keep the interest rate in its target range it has to (it has not other option) to give the reserves to the bank.
Ergo, the central bank can choose the quantity of money in the system or the interest rate, but not both at the same time.
Modern central banks target the interest rate. Ergo, all this quantity of money thing is nonsense.
Your friend has no money, but needs some.
You lend him your dollar.
Have you created money?
The IOU is an account balance. Have I created money?
Technically speaking, yes! (Neat, huh?)
If the IOU is accepted as currency, that is. You have rights to the original dollar and the borrower has rights to the IOU. Practically speaking, however, you haven't created money because nobody treats your IOU as money.
(Side note: this isn't a stupid question and doesn't deserve to be downvoted.)
In a bank, Person A gives the bank a dollar, the bank loans out (let’s say the full dollar for simplicity) and, some steps later, the dollar is out back into the bank (let’s say person B does this for simplicity).
Both A and B have title to a dollar, so yes, there’s more than one.
The bank created it by creating a liability for themselves. This is ok because long term the loaning of the dollar should create more than a dollar in value, so the liability will be covered.
Banks don't lend out balances. "Banks lend out balances" is just an analogy. (It was truer under the gold standard.)
Banks create money through lending and destroy money via write-offs. Periodically (in the U.S., at the end of the day) banks count up what they owe and what they're owed and make sure the ratio is legal. If not, they borrow (from each other or from the Fed) to make up the difference.
(For monetary purposes, savings accounts are checking accounts. Banks don't segregate savings from their balance sheets. Balances in savings account can be withdrawn just as easily as those in checking accounts.)
There are different definitions of money and saving accounts are included in M2 (“money and close substitutes”) but not in M1.
What about time deposits? For short maturities they are included in M3. And what about longer term depositss? Are banks creating money when they lend those out?
You're hanging on to the "banks lend out deposits" mental model. Stop that. The Bank of England has an accessible write-up on this: https://www.bankofengland.co.uk/-/media/boe/files/quarterly-....
Loans create deposits. Whether those deposits then end up in a checking account through a payroll service or a vendor's savings account through a payment for goods and then transfer is irrelevant.
A bank making a loan is trading one asset, cash, for another asset, a loan. If that's "creating money", then doesn't that imply that a loan is "money" and cash is not "money"?
The money lent does not go away when the check or whatever is cashed at another bank. The reserves follows the check. We're just working with more balance sheets now.
As long as the loan asset remains in the books, it earns interest which will add to bank equity.
We can keep bringing up details, but the basics remain the same. Bank lending creates money.
In fact banks also create money when they take cash deposits (and destroy money when they hand out cash).
If I deposit a $100 bill into a bank we’re increasing the money supply because I have $100 and so does the bank (until it spends it, trades it for a non-money asset or lends it out).
When a loan is taken, it is usually not taken just to sit in a bank account, it is to be spent. When that happens (by cash withdraw or transfer to a different bank), a bank must release/transfer base money, which it can get from cash deposits, incoming transfers or in exchange for some other assets.
Therefore, although banks create M1 money by lending, they are limited in practice by necessity to keep balance of base money. So it is more a distributed/emergent behavior, where each bank ability to create M1 money is limited by its market share and the rate of money production by other banks.
Down the line you suggested depositing money creates money because now you and the bank have a dollar. That’s not true, because the bank doesn’t have title to the dollar.
(And can deposit it at the federal reserve, if somehow you don’t think actual money is good enough to qualify as money.)
Custody isn’t title.
The deposit is their liability (obviously they can't spend it). The dollar is their asset. When you deposit the money into a bank that dollar is not yours anymore, the bank is not keeping it in custody for you.
Voila, new money!
From the Bank of England, banks are not intermediaries of loanable funds:
https://www.bankofengland.co.uk/working-paper/2015/banks-are...
The more details are given, the less interesting the special powers of commercial banks seem to be: not only is the amount of money that they can create limited to some multiple of the "real money" base, but they don't even lend that much out because it's not profitable.
The monetary base (physical currency plus banks deposits at the Fed) is currently $3.3tn.
M1 (circulating cash plus on demand deposits) is $3.9tn (the money multiplier is slightly above 1, but it was below 1 for most of this decade!).
M2 (including also savings accounts) is $14.9tn. M2/MB is 4.5, it has ranged between 3 and 5 over the last 10 years. It was between 8 and 12 in the four decades before 2008.
Central banks do have that special power, they can literally create money out of nothing. A normal bank can lend out a $, but they need to have taken a $ deposit, and it stays on the banks balance sheet.
Normal banks special powers are turning risky illiquid debt and making it appear risk free and liquid to depositors.
The biggest difference between bond issuers is that greater trust leads to lower interest rates and thus cheaper borrowing. For example, the US government sells bonds with lower interest rates than any company - buyers demand more return for a corporate bond, because a corporation is more likely to go bust.
For simplification, there are two kid of moneys, the 'government money' and the 'lending money' (my terminology).
Government money would be: cash and reserves.
Reserves come from two sources (both are the government) the Central Bank and the treasure. So, when the treasure spend in the economy is creating government money. Also, when the central bank 'give' reserves to the private banks is creating money. When the govenrment tax is destroying money and when the Central Bank retire reserves of the system is destroying money.
The 'lending money' is created by the private banks when lending, but it disappears when the money is payed back. This is a different kind of money, a less 'real' money if you want.
You can find more information in many places. For instance:
https://monetary.org/wp-content/uploads/2016/03/money-creati...
I think that the difference is important, because if one believes that a commercial bank can print fiat money the way a central bank does, then the idea of a bank run or bank collapse looks incomprehensible.