7 ms·

Money creation by fractional reserve banking has been Econ 101 for longer than anyone currently alive.

paganel 4y ago
I’m talking about commercial banks themselves being in the process of creating money, which in the UK was indeed not an established fact until the 2000s. I’m on my phone but I remember reading about that in an Economist issue a few years ago, I’ll try to find it once I get in front of a computer. 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. [1] https://archive.ph/7yXme https://archive.ph/7yXme
- notahacker 4y ago
  > I’m talking about commercial banks themselves being in the process of creating money, which in the UK was indeed not an established fact until the 2000s. 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.
  - scotty79 4y ago
    > 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.
    - notahacker 4y ago
      Private banks create monetary aggregates by lending it to private borrowers. The fact that money is created as credit means there are already natural limits to private bank money creation (there aren't unlimited numbers of bank customers who want to borrow money and pay back more later, and some of the people and companies that would like to borrow are not people the bank trusts to be able to make the repayment) 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...
      - scotty79 4y ago
        But if the private banks already have some money they can lend it again to borrowers. So they could be inflating money supply pretty much indefinitely. Sure, the number of private borrowers is limited but they are happy to sign all of their future life earnings away in exchange for some money now. And as supply of money grows inflation happens so borrowers need more and more money feeding creation of more money and further inflation. 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.
- lottin 4y ago
  The role that commercial banks in money creation has been known since much before the 2000s. It's all laid out in Keynes' General Theory which was published in 1936, and it wasn't even a novel idea at the time.
  - paganel 4y ago
    Like I said previously, the Bank of England wasn’t acknowledging that as a fact publicly until quite recently, which most probably had an effect on their actions/decisions. For example the same Keynes had some other better known takes which have also not been acknowledged as facts to this day.
    - lottin 4y ago
      So you're saying that the Bank of England was involved in a conspiracy that wouldn't acknowledge something that has been public knowledge for over a century?
lifeisstillgood 4y ago
I think that fractional reserve banking assumes it starts with a person saving in a bank, but the article asssumes this is the reverse """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
- notahacker 4y ago
  Yes, the article expands on simplifications used in economics textbooks as an illustration of how leverage can works. But none of this is "new understanding" of the fractional reserve system operates in practice, least of all to the Bank of England that oversees its operation. > 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...
throw0101c 4y ago
> Money creation by fractional reserve banking has been Econ 101 for longer than anyone currently alive. And it should have been removed decades ago. Tobin called it "the Old View" in 1963: * https://elischolar.library.yale.edu/cgi/viewcontent.cgi?article=1387&context=cowles-discussion-paper-series 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/2021/09/17/teaching-the-linkage-between-banks-and-the-fed-r-i-p-money-multiplier https://research.stlouisfed.org/publications/page1-econ/2021...

I’m talking about commercial banks themselves being in the process of creating money, which in the UK was indeed not an established fact until the 2000s. I’m on my phone but I remember reading about that in an Economist issue a few years ago, I’ll try to find it once I get in front of a computer. 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. [1] https://archive.ph/7yXme https://archive.ph/7yXme

notahacker 4y ago
> I’m talking about commercial banks themselves being in the process of creating money, which in the UK was indeed not an established fact until the 2000s. 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.
- scotty79 4y ago
  > 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.
  - notahacker 4y ago
    Private banks create monetary aggregates by lending it to private borrowers. The fact that money is created as credit means there are already natural limits to private bank money creation (there aren't unlimited numbers of bank customers who want to borrow money and pay back more later, and some of the people and companies that would like to borrow are not people the bank trusts to be able to make the repayment) 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...
    - scotty79 4y ago
      But if the private banks already have some money they can lend it again to borrowers. So they could be inflating money supply pretty much indefinitely. Sure, the number of private borrowers is limited but they are happy to sign all of their future life earnings away in exchange for some money now. And as supply of money grows inflation happens so borrowers need more and more money feeding creation of more money and further inflation. 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.
lottin 4y ago
The role that commercial banks in money creation has been known since much before the 2000s. It's all laid out in Keynes' General Theory which was published in 1936, and it wasn't even a novel idea at the time.
- paganel 4y ago
  Like I said previously, the Bank of England wasn’t acknowledging that as a fact publicly until quite recently, which most probably had an effect on their actions/decisions. For example the same Keynes had some other better known takes which have also not been acknowledged as facts to this day.
  - lottin 4y ago
    So you're saying that the Bank of England was involved in a conspiracy that wouldn't acknowledge something that has been public knowledge for over a century?

lifeisstillgood 4y ago

I think that fractional reserve banking assumes it starts with a person saving in a bank, but the article asssumes this is the reverse """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

notahacker 4y ago
Yes, the article expands on simplifications used in economics textbooks as an illustration of how leverage can works. But none of this is "new understanding" of the fractional reserve system operates in practice, least of all to the Bank of England that oversees its operation. > 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...

throw0101c 4y ago

> Money creation by fractional reserve banking has been Econ 101 for longer than anyone currently alive. And it should have been removed decades ago. Tobin called it "the Old View" in 1963: * https://elischolar.library.yale.edu/cgi/viewcontent.cgi?article=1387&context=cowles-discussion-paper-series 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/2021/09/17/teaching-the-linkage-between-banks-and-the-fed-r-i-p-money-multiplier https://research.stlouisfed.org/publications/page1-econ/2021...