This is a low-quality comment section. I strongly recommend reading the source, which is one of the best sources of how money works on the internet.
Please, if you think you know something on this topic and haven't read this pdf, just try and forget what you think you know and read it.
(Of course, now somebody will explain to me why the Bank of England doesn't actually know how money creation works, or is deliberately lying about it for some reason, and on it goes.)
If I'm not mistaken late into the 2000s authoritative sources like the Bank of England were still not completely on board with the idea that commercial banks themselves are in the process of actual money creation, a process explained described/explained by Schumpeter (I guess amongst many others) ever since back in the 1940s.
So a little bit of "not following the authoritative sources" on this one is understandable, as those authoritative sources themselves are pretty new to the idea.
Later edit: Found an Economist review [1] of this article/book itself, which I think it’s not what I had in mind but close enough:
> This often-cited short paper lucidly explains how commercial banks create money and central banks influence that process. It dispels many common misconceptions about money. For instance, most introductory economic textbooks say that commercial banks lend out the money that savers deposit in them. In fact banks can lend money and create corresponding deposits even without savings flowing in–in other words, banks are quite literally creating “new money” when they make a loan and a corresponding deposit.
Most probably you were thinking about Central Bank money creation, or, if not, those introductory economy courses seem to have not had any effect on the educated masses, hence why The Economist still has to re-iterate to its educated readers how money creation works.
There is a concerted effort amongst some fringe economists to make this argument, which is superficially plausible to the sort of laymen easily convinced that reading a couple of blogs arguing that an entire field is wrong is a substitute for reading anything written by that field.
But of course the Bank of England knew that commercial banks were involved in the process of creating money all along. Propping up private bank money was literally their job.
I thought their job was limiting the private money creation that without them would be totally unrestricted which would result in uncontrolled inflation and runs on banks.
The role of the Bank of England is providing the banks with central bank reserves they can borrow as and when needed to back that privately created money up. So it gets to influence the demand for borrowing private bank money by setting the basic interest rate at which the banks can borrow reserves (mainly by intervening in secondary markets for them, but that's an implementation detail), which means it can make it more expensive to borrow reserves, which will lead to banks lending money at higher interest rates to fewer people, which will lead to less money creation
This stuff is all in the paper...
The role of central bank as a limiter of credit action (through fractional reserve) is way more important than feeding new core money into the private banking system so it can be borrowed by private borrowers. Feeding new money is kinda optional and it's most important role is possibly enabling new banks to be created. In absence of it only companies that already have a lot of money could create a bank.
The other thing is that if economy development outpaces growth of money supply created by private banks whole system could get stuck in deflation. Which was not great last time it happened.
Banks have absolutely no incentive to provide money to everyone that wants to borrow all their future life earnings now, not because of hard limits on their funds but because they want their lending to be repaid at a profit (when it won't be, you get 2008). So the quantity of money at a given interest rate is ultimately set by the demand of creditworthy borrowers at that interest rate, which is certainly not unlimited.
Central banks were created to stop banks with solvent loan portfolios collapsing due to demands on their reserves, by ensuring banks could always borrow the reserves to back up the numbers on their spreadsheet. The "reserve requirement" (technically replaced by a capital requirement) isn't something central banks tinker with, and it's not "kinda optional" for them to provide enough reserves for the system's day to day needs. Instead, they influence credit action by adjusting the price of borrowing those reserves, and thus the demand for credit in the wider economy.
2008 happened because clearly the banks do have that incentive. The only thing that stops them are the regulations.
> The "reserve requirement" (technically replaced by a capital requirement) isn't something central banks tinker with,
In the last two decades that requirement was adjusted at least 5 times in my country so tinkering with it is definitely a tool that some central banks use. In the nineties it was even set to 30% to quench hyperinflation.
> Central banks were created to stop banks with solvent loan portfolios collapsing due to demands on their reserves, by ensuring banks could always borrow the reserves to back up the numbers on their spreadsheet.
First formal central bank, The Bank of England was created to finance the war. Central banks gradually acquired their modern roles as they developed.
The role you so much focus on is called being 'lender of last resort' to private banks. Private banks use it only if they can't get money cheaper anywhere.
> they influence credit action by adjusting the price of borrowing those reserves, and thus the demand for credit in the wider economy.
That the thing they do most often but not their most powerful tool.
2008 happened because banks overestimated the resilience of the value of housing collateral that backed their loans to an economic downturn, meaning they got back less than they lent out, not because they had any incentive to inflate money supply pretty much indefinitely, which they obviously didn't do (I mean, if they really had no practical constraints on money creation, they could have solved 2008 for themselves by loaning unlimited amounts to pump house prices back up again...). Inflation wasn't even high in 2008.
> The role you so much focus on is called being 'lender of last resort' to private banks. Private banks use it only if they can't get money cheaper anywhere.
And how do they get cheaper money elsewhere? They borrow it on the interbank lending market, the one which the central bank actively intervenes in to set the base interest rate by buying and selling bonds in sufficient quantities to drive the rate up or down (Why does the interbank lending market even exist? Because the 'lender of last resort' makes lending spare reserves to other banks a low risk activity equivalent to exchanging them for government bonds) Seriously, I suggest you read TFA which explains all this rather than continuing to insist that it is wrong ...
> That the thing they do most often but not their most powerful tool.
It's their most powerful tool in normal circumstances, and how monetary policy works. Preventing private credit creation isn't a tool, it's a nuclear weapon, and one most likely to be introduced and enforced by a government department which isn't a central bank...
I have a question though... I just found this: https://www.federalreserve.gov/monetarypolicy/reservereq.htm
Does that mean that currently US banks don't need to hold any fractional reserve? Or is this about something else similarly named?
Does US still have fractional reserve banking?
That kind of explains the surge of inflation. I guess all those other mechanisms are way to weak to counteract it.
To use your parlance, USA got nuked with money.
They still need to maintain some reserves to permit cash withdrawals and certain transfers, and are still incentivised to lend out at a higher rate than the base interest rate the central bank controls (and reserves still count towards the bank capital requirements which are the actual limiting factor on a particular bank's ability to lend). So the central bank still can act to encourage or discourage money being created by lending exactly as before, the banks just don't have an arbitrary reserve target to hit.
It's not a policy which hasn't been adopted much earlier in other parts of the world, or a cause of the current inflation. The UK had no reserve requirement at all during the mostly low inflation period since 2009, and small symmetric reserve targets chosen by the bank where they incurred a penalty for having too many as well as too few reserves between 1980 and 2009 (a period where inflation came down from pre-1980 record highs to an unprecedented long, stable period of low inflation)
It’s truly absurd to argue that banks have no incentive to limit lending to make sure they get paid back. The 2008 crisis proves no such thing. Banks simply made a lot of bad bets.
What's good for the company in the long run is not necessarily what really happens because companies consist mostly of short sighted decision makers driven by short term incentives. They will happily collectively burn their respective markets to the ground if it brings them short term profit.
What helps large corporations to survive this is their sheer inertia. Banks are kind of special because they, despite being huge, can topple very quickly.
Maybe people not understanding the mechanics of complicated things isn't actually the result of a conspiracy to stop them from understanding complicated things. Perhaps they'd also be somewhat more likely to understand how complicated things work if they didn't start from the premise that the people who know how they work are inherently untrustworthy...
For example the same Keynes had some other better known takes which have also not been acknowledged as facts to this day.
"""This article explains how, rather than banks lending out deposits that are placed with them, the act of lending creates deposits — the reverse of the sequence typically described in textbooks.(3)""" and
""" While the money multiplier theory can be a useful way of introducing money and banking in economic textbooks, it is not an accurate description of how money is created in reality. """
As such there is a new understanding of money developing - QE, lending and even MMT are involved.
So I think this article says quite clearly that the Econ 101 idea of fractional reserve lending as a money multiplier based on deposits made is just out of date
I do see this as a good argument to remove money creation from banks because
""" Banks first decide how much to lend depending on the profitable lending opportunities available to them """
which is determined by time horizons and risk appetite much more than central bank interest rates - and why most lending needs collateral.
Government lending (government as a VC) however has much longer time horizons
> Banks first decide how much to lend depending on the profitable lending opportunities available to them which is determined by time horizons and risk appetite much more than central bank interest rates
Hardly "much more", the delta between the rate the bank offers and the central bank rate is the bank's profit, adjusted over a timescale as a net present value calculation and reduced by expected losses. More importantly, it's also the cost of the loan to the person or company deciding on whether borrow or not, so when banks bump their loan rates up in response to a raise in the central bank rate, fewer people wish to borrow and so the bank has fewer profitable opportunities to lend. Time horizons and risk appetite just give banks and companies reason to turn down probably profitable/beneficial loans that are outside their comfort zone. And how does a central bank respond to the banks collectively reducing their risk appetites? It lowers the interest rates....
> Government lending (government as a VC) however has much longer time horizons
Ultimately I'd rather have market as VC (government can participate as well) than government as the only VC...
1. It's nuts that all central banks globally have one lever to pull - interest rates.
2. yes the central bank sets the interest rate, but the banks choose how much to lend and to whom. I think that if interests rates are at zero, that implies (?) an infinite amount of investment opportunities - ability to grow productive capacity. And yet most loans are real estate or real estate backed (ie collateral). VC is a drop in the ocean of land based lending - and yet our entire economy is based on small amounts of land use for amazing factories and power stations
3. banks aren't doing the business of lending to those capable of productive capacity generation - and they won't cause they want safe near term returns.
VC speculative investment should not be the small corner case - it should be the norm. Industry investment should be not left to crazies willing to risk family house or wealthy with enough to spare.
create money and give it to a million startups
And it should have been removed decades ago. Tobin called it "the Old View" in 1963:
* https://elischolar.library.yale.edu/cgi/viewcontent.cgi?arti...
See also "Teaching the Linkage Between Banks and the Fed: R.I.P. Money Multiplier":
* https://research.stlouisfed.org/publications/page1-econ/2021...
It's weird how people get agitated over a topic that's the economics equivalent of the pythagorean trigonometric identity.
The fact that numbers appear to be involved changes nothing.
It's perfectly reasonable to ask if banks are doing what they claim to be doing.
Especially given the banking sector's very poor record of creating widespread stable prosperity through straightforwardness and integrity.
This happens frequently on weekends.
There's even patterns to it. I've learned to avoid posting to (or even reading) comment sections touching certain topics, and to postpone submissions of certain stories until Monday, when the quality of discussion gets back to normal.
You can see this even in tech. Most of the commenters have been handed incredibly powerful database / IDE / computation tools which makes them think they're very smart to be playing around with it. What they don't realize is high level tools are not meant for people who want to understand the tooling. They are meant for users of the tools whose task is something else entirely. So you get folks who don't understand how a simple race condition would occur or something else very obvious to folks who have done a bit of low level programming, but they will hold forth on mutexes and locks as though they invented them.
The patterns I noticed mainly revolve around certain topics.
I quite often write and post a comment to correct a misconception and just end up deleting it because the person I am replying to is going to dismiss what I am posting anyways. Now I don’t waste my time.
> when households choose to save more money in bank accounts, those deposits come simply at the expense of deposits that would have otherwise gone to companies in payment for goods and services. Saving does not by itself increase the deposits or ‘funds available’ for banks to lend. Indeed, viewing banks simply as intermediaries ignores the fact that, in reality in the modern economy, commercial banks are the creators of deposit money.
That could be taken to mean that savings accounts have only a second order contribution on the amount of money banks loan out, it could also mean that savings accounts reduce the amount of money banks can loan out.
I believe that passage is looking at banking from a systems level, and that savings may not directly impact loans a bank makes, but at a systemic level has an end result of reducing loans. It’s not clear at what level they’re taking about here.
A few days ago there was a post on here about how technical documentation only makes sense if you already have a working mental model of the system you’re working with. I feel like this may be an example of this.
The money that you don't deposit but you pay a company eventually also ends up in a bank account, of the company, of it's employees, of it's suppliers.
From the banking system point of view it's the same money amount, just split differently between accounts.
I love the format of discussing articles/links, but the amount of people confidently pretending they know what they are talking about that you see when you visit a topic you're an expert on is wild. It must be the same for all topics, I just don't notice when I'm not an expert myself.
Additionally, if a subject matter does not lend itself to experimentation or feedback mechanisms then you can easily have all the experts be consistently wrong for decades due to group think or conformal pressures.
I agree generally in the end you'd have to trust the forum admins to publish some rules and follow them, but that's already the case in any forum. I'm sure some people would like it and some would hate it. It's at least an interesting alternative to the majority of people not knowing what they are talking about but confidently posting as if they do, even if it's just one of the kinds of forums in the mix in the world.
Heterodox monetary theories are a particularly good example of this...
Or maybe you mean you want people to be able to share credentials like a degree and claim expertise without us having to do the extra work of judging the quality of those qualifications?
These endorsements are highly sought by the larpers and confidently incorrect. Meanwhile the actual experts aren’t as interested in going through the process of getting the mark.
One pattern I’ve seen repeated across many forums over decades of internet use: The confidently incorrect have more time and energy to dedicate to online misinformation than the actual experts. I’ve watched many knowledgeable forum users eventually tire of participation and leave communities because they get overrun by younger, inexperienced people who are still in the phase of life where we think we know everything.
(To be fair, even many economists have a fairly nebulous understanding.)
What's somewhat ironic is that the some of the actual 'Austrian' economists like George Selgin have a pretty good handle on the topic, but 'Internet Austrians' invariable are some of the worst misunderstanders.
An example, nobody uses cash for payments anymore, demand for bank notes must be down. And yet: https://www.rba.gov.au/publications/bulletin/2021/mar/pdf/ca...
Your naive hypothesis is true. The ratio of cash to non-cash has been decreasing over time, as more digital payments are used. As everyone also knows, cash is a nominal value, it doesn't inflate. Anyone trying to intuit cash demand would be thinking about inflation rates and nominal gdp growth.
In fact this naive thinking is a pretty good explanation for the graph in your source: https://www.rba.gov.au/publications/bulletin/2021/mar/images...
I think digital payments would explain a lot of why the correlation sharply reverses in 2020.
The problem is if you want to go further and say; since digital payments will increase during the pandemic, all demand for cash will decrease. I disagree that's an intuitive idea.
Covid changed the money supply and peoples behavior rapidly, saying you can't use intuition under higher uncertainty is a tautology - no field is immune to this. Also going past intuition, the decline in cash as a percentage of total money accelerated, due to the M2 increase being much larger.
Just because covid shocked a few things doesn't mean that economics insn't intuitive or that peoples intuition is wrong. It's like trying to reason about terrorist attack danger using data just after 9/11.