7 ms·

I’m asking a practical question, not broad economic theories (which are mostly bs). How does newly created money (which first goes in commercial bank reserves)

I’m asking a practical question, not broad economic theories (which are mostly bs). How does newly created money (which first goes in commercial bank reserves) finally ends being used to buy houses and stocks?

cs702 4y ago
The same way previously created money ends up being used for anything in the private sector: by the actions of individuals, businesses, and non-governmental organizations. If money is cheaper to borrow, they may choose to borrow more, or take on more risk, or what have you. But money does not "go into assets." That's a misconception. Money trades hands: For every buyer of a house there is a corresponding seller, and for every buyer of a share of stock there is a corresponding seller. Asset prices can rise, or fall, with each trade.
- CraigJPerry 4y ago
  >> But money does not "go into assets." That's a misconception How would you describe the situation when you purchase a treasury bill then? You gave money, the money you gave ceased to exist in the economy - it is no longer available for anyone to spend, you gained an asset.
  - zozbot234 4y ago
    Unless you purchased a treasury bill from the central bank as part of a money-draining operation, the money is still there. Your counterparty has sold a treasury bill and received money for it, that she'll most likely spend elsewhere.
    - CraigJPerry 4y ago
      We’re not talking about the unless case though - as you say the money would still exist in that case.
  - cs702 4y ago
    > How would you describe the situation when you purchase a treasury bill then? Your cash (i.e., money) goes to the seller of the treasury bill. If the seller is a private investor, your cash goes to the private investor (e.g., a mutual fund, a pension plan, an individual). If the seller is the US Treasury (i.e., you bought a newly issued treasury bill), your cash goes to the US Treasury, which will deposit it, and later on, will use it to pay for the federal government's expenses, including bond interest. (Recall that, unlike the Fed, the Treasury cannot issue newly created money. The Treasury must borrow or collect taxes from the private sector to fund federal spending.) If the seller is the Fed (through one of its primary dealers, acting as an intermediary), the trade is quantitative tightening.
    - CraigJPerry 4y ago
      >> If the seller is a private investor This case is not of interest >> If the seller is the US Treasury This case IS of interest >> Recall that, unlike the Fed, the Treasury cannot issue newly created money This is where it begins to unravel and fall apart. What you say is true in theory only, it’s not true in practice: The fed finances the primary dealer banks that participate in treasuries auctions - it accepts treasuries as collateral for repos. The primary dealer banks are obligated to stand ready to purchase treasuries and the Federal Reserve ensures there are sufficient reserves to do so by supplying them through temporary repos (a matched purchase of Treasury debt with a requirement that the seller must repurchase later). While the Federal Reserve is not in that case directly buying the new issue directly from the Treasury, it uses the open market purchase to buy an existing bond in order to provide reserves needed for a private bank to buy the new security. The end result is exactly the same as if the central bank had bought directly from the Treasury. The fed does also buy treasuries (the fed holds around 10% of treasuries issued - https://fred.stlouisfed.org/series/TREAST https://fred.stlouisfed.org/series/TREAST). EDIT: moved paragraph for clarity
- deleted 4y ago
  [deleted]
somewhereoutth 4y ago
Commercial banks actually create the money (by issuing loans) that is used to buy houses (mortgages) and stocks (leverage). Central banks affect this process by adjusting the rate to which they lend to the commercial banks, and by quantitative easing /tightening which has a similar effect on long term rates. Rates are low, more loan value is issued (because the income stream servicing the loan translates into a larger loan amount), asset prices go up. And conversely.
- mrcode007 4y ago
  This is the correct answer.
vinyl7 4y ago
The economy is always inflationary. Money today is worth less than it is tomorrow. Money that the bank has is just rotting away, becoming less valuable over time. Banks need to take the cash they have and invest it in something to offset the inflationary losses. Because bonds weren't paying much interest, it was a better return for the bank to loan out the money for mortgages, investors, etc. Eventually those loans become a part of someone's paycheck or into their bank account (ie home sale that ended up with a 2-300% return). Compared to the bank buying bonds which essentially removes money from the economy.
- zie 4y ago
  Deflation exists, the US Federal Reserve has a 1 page article about it here, in case you need proof for some reason: https://files.stlouisfed.org/files/htdocs/publications/es/10/ES1030.pdf https://files.stlouisfed.org/files/htdocs/publications/es/10... Otherwise, your comment is like grade school levels of understanding of how this all works. Modern banks have the ability to create money.
zozbot234 4y ago
> How does newly created money (which first goes in commercial bank reserves) finally ends being used to buy houses and stocks? Well, you have some newly created money, whilst the demand for holding money balances (which depends on the price level and the volume of economic activity) stays the same. So what happens is that money is exchanged away like a hot potato until the demand for money balances rises to match the extra created money. In the short run, this is a mixture of higher prices and a higher volume of expected economic activity, both of which would raise asset prices.
- CraigJPerry 4y ago
  >> you have some newly created money, whilst the demand for holding money balances … stays the same This is a contradiction. You can’t create money without a demand for it first. In this specific case through the demand for money in exchange for treasuries/MBS/etc. >> So what happens is that money is exchanged away like a hot potato until the demand for money balances rises to match the extra created money This view derives from monetarist theory, it’d be fair to say this view enjoys less support today than it did in the past. As with all macro views, it’s primarily BS with perhaps a little bit of truth that may or may not apply in any given real world scenario. Probably not a useful model.
  - zozbot234 4y ago
    > You can’t create money without a demand for it first. Why not? At the individual level it literally works the same as any purchase of existing assets. In practice, the counterparty of that transaction will probably spend that money in turn on something else that she actually planned to hold. > This view derives from monetarist theory, it’d be fair to say this view enjoys less support today than it did in the past. Well, the biggest flaw of monetarist theory is that it treats "the creation of money" as if it was somehow special, whereas what really matters is the product of money and velocity. (Velocity can be seen as a reflection of external changes in the demand for money balances. It also explains how money can seemingly be "created" out of thin air by entities other than the central bank; what we're really seeing in these expanded money measurements is higher velocity for the actual "high-powered" money that the central bank issues.)

cs702 4y ago

The same way previously created money ends up being used for anything in the private sector: by the actions of individuals, businesses, and non-governmental organizations. If money is cheaper to borrow, they may choose to borrow more, or take on more risk, or what have you. But money does not "go into assets." That's a misconception. Money trades hands: For every buyer of a house there is a corresponding seller, and for every buyer of a share of stock there is a corresponding seller. Asset prices can rise, or fall, with each trade.

CraigJPerry 4y ago
>> But money does not "go into assets." That's a misconception How would you describe the situation when you purchase a treasury bill then? You gave money, the money you gave ceased to exist in the economy - it is no longer available for anyone to spend, you gained an asset.
- zozbot234 4y ago
  Unless you purchased a treasury bill from the central bank as part of a money-draining operation, the money is still there. Your counterparty has sold a treasury bill and received money for it, that she'll most likely spend elsewhere.
  - CraigJPerry 4y ago
    We’re not talking about the unless case though - as you say the money would still exist in that case.
- cs702 4y ago
  > How would you describe the situation when you purchase a treasury bill then? Your cash (i.e., money) goes to the seller of the treasury bill. If the seller is a private investor, your cash goes to the private investor (e.g., a mutual fund, a pension plan, an individual). If the seller is the US Treasury (i.e., you bought a newly issued treasury bill), your cash goes to the US Treasury, which will deposit it, and later on, will use it to pay for the federal government's expenses, including bond interest. (Recall that, unlike the Fed, the Treasury cannot issue newly created money. The Treasury must borrow or collect taxes from the private sector to fund federal spending.) If the seller is the Fed (through one of its primary dealers, acting as an intermediary), the trade is quantitative tightening.
  - CraigJPerry 4y ago
    >> If the seller is a private investor This case is not of interest >> If the seller is the US Treasury This case IS of interest >> Recall that, unlike the Fed, the Treasury cannot issue newly created money This is where it begins to unravel and fall apart. What you say is true in theory only, it’s not true in practice: The fed finances the primary dealer banks that participate in treasuries auctions - it accepts treasuries as collateral for repos. The primary dealer banks are obligated to stand ready to purchase treasuries and the Federal Reserve ensures there are sufficient reserves to do so by supplying them through temporary repos (a matched purchase of Treasury debt with a requirement that the seller must repurchase later). While the Federal Reserve is not in that case directly buying the new issue directly from the Treasury, it uses the open market purchase to buy an existing bond in order to provide reserves needed for a private bank to buy the new security. The end result is exactly the same as if the central bank had bought directly from the Treasury. The fed does also buy treasuries (the fed holds around 10% of treasuries issued - https://fred.stlouisfed.org/series/TREAST https://fred.stlouisfed.org/series/TREAST). EDIT: moved paragraph for clarity
deleted 4y ago
[deleted]

somewhereoutth 4y ago

Commercial banks actually create the money (by issuing loans) that is used to buy houses (mortgages) and stocks (leverage). Central banks affect this process by adjusting the rate to which they lend to the commercial banks, and by quantitative easing /tightening which has a similar effect on long term rates. Rates are low, more loan value is issued (because the income stream servicing the loan translates into a larger loan amount), asset prices go up. And conversely.

mrcode007 4y ago
This is the correct answer.

vinyl7 4y ago

The economy is always inflationary. Money today is worth less than it is tomorrow. Money that the bank has is just rotting away, becoming less valuable over time. Banks need to take the cash they have and invest it in something to offset the inflationary losses. Because bonds weren't paying much interest, it was a better return for the bank to loan out the money for mortgages, investors, etc. Eventually those loans become a part of someone's paycheck or into their bank account (ie home sale that ended up with a 2-300% return). Compared to the bank buying bonds which essentially removes money from the economy.

zie 4y ago
Deflation exists, the US Federal Reserve has a 1 page article about it here, in case you need proof for some reason: https://files.stlouisfed.org/files/htdocs/publications/es/10/ES1030.pdf https://files.stlouisfed.org/files/htdocs/publications/es/10... Otherwise, your comment is like grade school levels of understanding of how this all works. Modern banks have the ability to create money.

zozbot234 4y ago

> How does newly created money (which first goes in commercial bank reserves) finally ends being used to buy houses and stocks? Well, you have some newly created money, whilst the demand for holding money balances (which depends on the price level and the volume of economic activity) stays the same. So what happens is that money is exchanged away like a hot potato until the demand for money balances rises to match the extra created money. In the short run, this is a mixture of higher prices and a higher volume of expected economic activity, both of which would raise asset prices.

CraigJPerry 4y ago
>> you have some newly created money, whilst the demand for holding money balances … stays the same This is a contradiction. You can’t create money without a demand for it first. In this specific case through the demand for money in exchange for treasuries/MBS/etc. >> So what happens is that money is exchanged away like a hot potato until the demand for money balances rises to match the extra created money This view derives from monetarist theory, it’d be fair to say this view enjoys less support today than it did in the past. As with all macro views, it’s primarily BS with perhaps a little bit of truth that may or may not apply in any given real world scenario. Probably not a useful model.
- zozbot234 4y ago
  > You can’t create money without a demand for it first. Why not? At the individual level it literally works the same as any purchase of existing assets. In practice, the counterparty of that transaction will probably spend that money in turn on something else that she actually planned to hold. > This view derives from monetarist theory, it’d be fair to say this view enjoys less support today than it did in the past. Well, the biggest flaw of monetarist theory is that it treats "the creation of money" as if it was somehow special, whereas what really matters is the product of money and velocity. (Velocity can be seen as a reflection of external changes in the demand for money balances. It also explains how money can seemingly be "created" out of thin air by entities other than the central bank; what we're really seeing in these expanded money measurements is higher velocity for the actual "high-powered" money that the central bank issues.)