An economics, investment, trading and policy blog with a focus on Modern Monetary Theory (MMT). We seek the truth, avoid the mainstream and are virulently anti-neoliberalism.
“ Fortunately bank B has an alternative that person C does not. They can move their deposit to the central bank.”
Not if the CB is simultaneously implementing a policy of Reserve Assets reduction... ie “quantitative tightening!” ... so banks have “less reserves to lend out!”...
“Fortunately bank B has an alternative that person C does not. They can move their deposit to the central bank.” Not sure about that.
Reason is that central banks do not accept commercial bank created money. And commercial bank created money is the only money on the model set up by NeilW up to the above quoted two sentences.
A more realistic model would consist of saying that when the deposit at bank A made by D is shifted to bank B, bank B demands reserves worth the amount of the deposit off bank A. Ergo bank A has to borrow reserves off the central bank, which are deposited in the account of bank B in the books of the central bank.
That shifting of reserves between accounts at the central banks which matches payments moving between commercial banks is known as the “dual circuit”. There’s plenty articles out there which explain the dual circuit.
In short, what induces banks to pay interest on deposits is at least to some extent, the fact that if they do not acquire deposits, they run short of reserves, and have to borrow reserves off the central bank or other banks: not a desirable position to be in for too long.
But even if central banks paid no interest on reserves, commercial banks would still pay interest to depositors (and bond holders). Reason is that commercial banks act partially as intermediaries between creditors (depositors and bond holders) and debtors (those who banks lend to) – while of course commercial banks do not act JUST AS intermediaries: they also create money out of thin air.
Thus seems to me there are at least three reasons banks pay interest to depositors: 1, to avoid paying interest on reserves borrowed from central banks and other commercial banks, 2 the fact that they are intermediaries between creditors and debtors and creditors will inevitably want their cut of interest paid by debtors, 3 (NeilW’s reason), the fact that if the central bank is paying interest on reserves, depositors will demand a cut of that as well, else they’ll go elsewhere.
Letting private banks create money is a complete farce. First, it costs CENTRAL banks nothing to create money, as Milton Friedman said, whereas private banks have to check on the credit-worthiness of borrowers before supplying them with money and normally have to obtain collateral off them. That involves significant costs.
Second, private banks create money in a totally irresponsible way, i.e. in a PRO-CYCLICAL way. In contrast, central banks create money in an ANTI-CYCLICAL way (e.g. during recessions).
Third, it is perfectly feasible to achieve full employment with central bank money alone: indeed, as MMTers have long said, it’s simply a case of creating and spending enough CB money into the economy.
Fourth, privately issued money is so unreliable that it has to be backed by taxpayer funded deposit insurance and multi billion bail outs for banks in trouble. And that raises the question as to what extent so called “privately issued” money really is privately issued, or whether it isn't really just a second and entirely unnecessary form of public money creation.
"Reason is that central banks do not accept commercial bank created money"
That doesn't matter. It's created on demand via the discounting process intra-day at the central bank.
Bank A needs to offer a payment service to person D or they won't take the loan. Therefore the loan is posted as collateral at the central bank and Bank A can go overdrawn on the day. That is transferred to Bank B who mark up Person C's account.
The transfer, however, is functionally a loan from Bank B to the central bank *in central bank money*. It's a forced loan, which the CB remunerates, as part of the central clearing framework.
The problem Bank A has now is that to clear the central bank it has to obtain a loan from Bank B which is settled in central bank money - but only because it decided to use the central clearing house in the first place.
Remember that using the central bank for clearing is merely a convenience for commercial banks. There is no need for them to do so. The could just as easily do it over the counter without any central bank money involved at all.
"But even if central banks paid no interest on reserves, commercial banks would still pay interest to depositors"
Yet as the evidence of the Eurozone currently shows, banks are charging commercial entities interest on their deposits to pass thru the negative rates imposed by the ECB.
Your theory is debunked as well Neil as evidenced by the events around September 15 2019.... rates went well above target until Fed increased Reserves back up above the 10% system RRR minimum...
NeilW says “Remember that using the central bank for clearing is merely a convenience for commercial banks. There is no need for them to do so. The could just as easily do it over the counter without any central bank money involved at all.”
I’m fascinated. So if commercial banks do not use central bank money to settle up with, what exactly do they use “over the counter” to settle up with? They certainly COULD settle up with gold, diamonds, real estate, stock exchange shares, govt bonds, etc etc but that would certainly not be “just as easy”.
Re NeilW’s last three paras, I’m baffled as to why the fact that commercial banks to some extent pass on interest (positive or negative) to their customers (which I’m sure they do) “debunks” my “theory” that there are other reasons for commercial banks charging their customers interest on loans.
By way of illustration, take the extreme case of where pay day lenders charge borrowers several hundred percent. That high rate of interest is explained 99% by the high risk and high administration cost per $ of such loans. Central bank rates have virtually nothing to do with it.
"what exactly do they use “over the counter” to settle up with?"
Each other. That's what OTC means
The entries are on the blog post. If Bank A transfers the deposit of C to Bank B, then Bank B automatically becomes the depositor in Bank A in stead.
IOW C had Bank A money, and Bank B must discount bank A money into is own money to give C Bank B money. That can be at a fixed or floating rate, but normally fixed or C wouldn't move/D would never take the loan in the first place.
That's how pegs between finance houses arise. Then they realise this is all very expensive in collateral terms and create a clearing house.
"Your theory is debunked as well Neil as evidenced by the events around September 15 2019.... rates went well above target until Fed increased Reserves back up above the 10% system RRR minimum..."
Not really Matt - as you well know.
Some of us live in sensible countries that know how to do banking properly and don't have silly counterproductive liquidity ratios
11 comments:
“ Fortunately bank B has an alternative that person C does not. They can move their deposit to the central bank.”
Not if the CB is simultaneously implementing a policy of Reserve Assets reduction... ie “quantitative tightening!” ... so banks have “less reserves to lend out!”...
“Fortunately bank B has an alternative that person C does not. They can move their deposit to the central bank.” Not sure about that.
Reason is that central banks do not accept commercial bank created money. And commercial bank created money is the only money on the model set up by NeilW up to the above quoted two sentences.
A more realistic model would consist of saying that when the deposit at bank A made by D is shifted to bank B, bank B demands reserves worth the amount of the deposit off bank A. Ergo bank A has to borrow reserves off the central bank, which are deposited in the account of bank B in the books of the central bank.
That shifting of reserves between accounts at the central banks which matches payments moving between commercial banks is known as the “dual circuit”. There’s plenty articles out there which explain the dual circuit.
In short, what induces banks to pay interest on deposits is at least to some extent, the fact that if they do not acquire deposits, they run short of reserves, and have to borrow reserves off the central bank or other banks: not a desirable position to be in for too long.
But even if central banks paid no interest on reserves, commercial banks would still pay interest to depositors (and bond holders). Reason is that commercial banks act partially as intermediaries between creditors (depositors and bond holders) and debtors (those who banks lend to) – while of course commercial banks do not act JUST AS intermediaries: they also create money out of thin air.
Thus seems to me there are at least three reasons banks pay interest to depositors: 1, to avoid paying interest on reserves borrowed from central banks and other commercial banks, 2 the fact that they are intermediaries between creditors and debtors and creditors will inevitably want their cut of interest paid by debtors, 3 (NeilW’s reason), the fact that if the central bank is paying interest on reserves, depositors will demand a cut of that as well, else they’ll go elsewhere.
“depositors will demand a cut of that as well, “
Ralph I believe currently interest on savings accounts well exceeds IOR...
Every thing Neil says happens here THE EXACT OPPOSITE happened here Sept 15, 2019...
THE EXACT OPPOSITE...
Figure it the fuck out...
Letting private banks create money is a complete farce. First, it costs CENTRAL banks nothing to create money, as Milton Friedman said, whereas private banks have to check on the credit-worthiness of borrowers before supplying them with money and normally have to obtain collateral off them. That involves significant costs.
Second, private banks create money in a totally irresponsible way, i.e. in a PRO-CYCLICAL way. In contrast, central banks create money in an ANTI-CYCLICAL way (e.g. during recessions).
Third, it is perfectly feasible to achieve full employment with central bank money alone: indeed, as MMTers have long said, it’s simply a case of creating and spending enough CB money into the economy.
Fourth, privately issued money is so unreliable that it has to be backed by taxpayer funded deposit insurance and multi billion bail outs for banks in trouble. And that raises the question as to what extent so called “privately issued” money really is privately issued, or whether it isn't really just a second and entirely unnecessary form of public money creation.
"Reason is that central banks do not accept commercial bank created money"
That doesn't matter. It's created on demand via the discounting process intra-day at the central bank.
Bank A needs to offer a payment service to person D or they won't take the loan. Therefore the loan is posted as collateral at the central bank and Bank A can go overdrawn on the day. That is transferred to Bank B who mark up Person C's account.
The transfer, however, is functionally a loan from Bank B to the central bank *in central bank money*. It's a forced loan, which the CB remunerates, as part of the central clearing framework.
The problem Bank A has now is that to clear the central bank it has to obtain a loan from Bank B which is settled in central bank money - but only because it decided to use the central clearing house in the first place.
Remember that using the central bank for clearing is merely a convenience for commercial banks. There is no need for them to do so. The could just as easily do it over the counter without any central bank money involved at all.
"But even if central banks paid no interest on reserves, commercial banks would still pay interest to depositors"
Yet as the evidence of the Eurozone currently shows, banks are charging commercial entities interest on their deposits to pass thru the negative rates imposed by the ECB.
So that theory is debunked as well.
Your theory is debunked as well Neil as evidenced by the events around September 15 2019.... rates went well above target until Fed increased Reserves back up above the 10% system RRR minimum...
NeilW says “Remember that using the central bank for clearing is merely a convenience for commercial banks. There is no need for them to do so. The could just as easily do it over the counter without any central bank money involved at all.”
I’m fascinated. So if commercial banks do not use central bank money to settle up with, what exactly do they use “over the counter” to settle up with? They certainly COULD settle up with gold, diamonds, real estate, stock exchange shares, govt bonds, etc etc but that would certainly not be “just as easy”.
Re NeilW’s last three paras, I’m baffled as to why the fact that commercial banks to some extent pass on interest (positive or negative) to their customers (which I’m sure they do) “debunks” my “theory” that there are other reasons for commercial banks charging their customers interest on loans.
By way of illustration, take the extreme case of where pay day lenders charge borrowers several hundred percent. That high rate of interest is explained 99% by the high risk and high administration cost per $ of such loans. Central bank rates have virtually nothing to do with it.
@ Ralph
Large commercial banks use clearing houses and clear the residual at the cb. It is less expensive for them.
The Clearing House
Small banks use the cb payments system directly for all their clearing unless they are correspondent bank affiliated with a large bank.
That is how I understand it anyway.
"what exactly do they use “over the counter” to settle up with?"
Each other. That's what OTC means
The entries are on the blog post. If Bank A transfers the deposit of C to Bank B, then Bank B automatically becomes the depositor in Bank A in stead.
IOW C had Bank A money, and Bank B must discount bank A money into is own money to give C Bank B money. That can be at a fixed or floating rate, but normally fixed or C wouldn't move/D would never take the loan in the first place.
That's how pegs between finance houses arise. Then they realise this is all very expensive in collateral terms and create a clearing house.
Banking is largely about optimising collateral.
"Your theory is debunked as well Neil as evidenced by the events around September 15 2019.... rates went well above target until Fed increased Reserves back up above the 10% system RRR minimum..."
Not really Matt - as you well know.
Some of us live in sensible countries that know how to do banking properly and don't have silly counterproductive liquidity ratios
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