This is a response to an article by Nick Rowe, "Repeat after me: people cannot and do not 'spend' money", in which he states that banks lend reserves. As can be guessed from the title of my article, I disagree. But the difference in view is more nuanced than is suggested by the title. There is a good deal of disinformation spread about banking on the internet, so I think this is an important subject. Although this is fairly theoretical, it touches on the topic of the effectiveness of Quantitative Easing (spoiler: it isn't effective).Bond Economics
No, Banks Do Not Lend Reserves
Brian Romanchuk
Brian Romanchuk
Bank reserves are settlement balance held at the central bank for clearing in the payments system and to exchange for vault cash to provide customer with the means to settle spot transaction that need no further clearing. Bank reserves in the payments system come into play after intra-bank and inter-bank clearing. Vault cash is counted as bank reserves for the purpose of the reserve requirement if imposed. Cash in circulation is not counted in bank reserves. The public does not hold bank reserves in any form. Cash is exchangeable for reserve balances at the central bank, which the public has no access to and where only member institutions are permitted to hold accounts.
Claiming that banks lend out reserves misconstrues the meaning of bank reserves. Bank reserves are liabilities of the cb and when the cb receives reserve balances from a member institution, it marks down its own liabilities. When the cb receives bank reserves in payment of taxes, it marks up the Treasury account by an equal amount.
In this way, a private deposit account is marked down and the spendable money supply (stock) called M1 is reduced. The credit to the Treasury account is not considered part of the spendable money supply until it is used in clearing when Treasury directs the cb to mark up a bank's reserve account, resulting in a credit to a customer's account, for example, a Social Security deposit. This increase in a demand deposit account results in an increase in M1 money supply.
Bank reserves, which are more accurately called settlement balances, never leave the the payments system run through the central bank's accounting system, other than bank reserves being exchanged for vault cash, which counts toward the bank's reserve balance. Vault cash loses this status when a customer withdraws cash.
7 comments:
The amount of mental energy that has been devoted to this topic over the past five years is out of all proportion to the actual policy payoff that comes from getting the answer exactly right. At this point, it has degenerated into just another idle passtime in the garden of ivory tower wrangling.
When banks lend, they usually issue IOUs in the form of deposit account balances. These IOUs commit them to making interbank payments at the depositor's demand, or to redemption of the IOUs for cash at the depositor's demand. Have they in all literal exactness "loaned their reserves?" No. Have they by making the loan issued a claim against their reserves? Yes. Does the difference between the two matter much? No.
When it comes to engaged participation in the process of formulating specific economic policies and developing a concrete agenda for social change and progress, heterodox economists have proven that they are just as much aimless wankers as their orthodox opponents.
I was expecting a comment along those lines, and I see your point. In my defence, my blog is fairly new, and so I had not covered the topic. Going forward, I can now back link to my article if the topic comes up.
But the size of the Fed's balance sheet does raise a lot of concern, so the topic is not entirely useless. If you want a specific policy, I guess you can read between the lines of my article and state "do not do QE".
I just have to disagree with you on this one Dan.
The loanable funds model is directly responsible for at least the following beliefs:
1) Wicksellian interest rate
2) markets set interest rates = bond vigilantes
3)Govt deficits = higher interest rates which then lead to the CBO projecting that interest payments will become 25% or more of the budget of the coming decades.
4) Banks don't matter in models since they are just acting as intermediaries
5) Therefore private debt growth does not impact unemployment and GDP activity.
6) the money supply is fixed or set by the CB, leads to more fixed FX thinking
I'm sure that I could think of more if I gave it more than 30 seconds of thought. But these are basically the biggest problems with macroeconnomics today, and the loanable funds framework underlies all of these. I honestly can't think of anything in economics that is more important that getting this right.
And what about just good old-fashioned intellectual honesty? The system works one way or the other, it can't be both simultaneously, so I personally prefer people to analyze the world based off of whats real instead of whats imagined, maybe thats the scientist in me speaking.
Auburn is correct. The CBO "scores" all budgets assuming that higher debt will "crowd out" private investment, lower economic growth, and increase interest rates. Thus I think you can legitimately say that all of the "major" budget proposals considered by Congress are based on a false assumption.
That would seem to be a big deal.
Actually I don't think I disagree with anything Brian said in his article. I just don't think the question of whether banks do or do not lend their reserves is all that important to understanding the constraints on bank lending. As he points out there are centralized banking systems, like Canada's, that do not make much use of reserves. Nevertheless, banks do lend against their assets. Those assets need not all be in the form of "funds", but bank deposit balances are genuine liabilities of the bank where the account is held: they are claims against the assets of the bank.
What I think we need to guard against is the mistaken view that, once upon a time, I called "hyper-endogeneity." This is the notion that banks effectively operate their own quasi-governmental printing press that allows them to issue not just liabilities, but to manufacture their own assets "from thin air".
I would agree that "hyper-endogenity" is something that comes up in things like internet comments. I referred to this tendency to attribute too much power to banks, which people should be careful about.
I very much agree with Dan and Brian wrt the importance of reserves and endogenous money when trying to understand the workings of the economy.
However, we are not the ones that use the minor detail of reserve operations to draw sweeping conclusions about the way the economy works.
Of course I'm speaking about mainstream econommists here. It is just a minor detail operationally, but as I pointed out in my first comment, it makes a deep impact on the mainstream conventional wisdom and thus policy.
And from the POV that results matter, having loanable funds be the model by which we base policy that actually impacts 100's of millions of lives, its just about the most important things imaginable. A point Dan is ignoring.
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