[hidenotslide]

Here is a simple way to demonstrate the point of the article. If I deposit $100 in a bank, the bank can lend out around $90 to someone else (fractional reserve banking). That person now deposits the money at another bank, and the "money supply" is $190 instead of $100.

On the other hand when a central bank "prints money", they use it to buy assets with an equivalent value, so there is no net transfer of wealth done by the central bank. That assumes they don't affect asset prices, which not a great assumption.

The way central banks affect the money supply is through interest rates to change the supply and demand of private loans that banks make, which indirectly affects the money supply.

[millstone]

> If I deposit $100 in a bank, the bank can lend out around $90 to someone else (fractional reserve banking)

This is the textbook explanation which the article strongly rejects. In practice the bank will lend out as much as possible - it is not effectively constrained by reserve requirements since it can and will simply borrow the difference. What constrains it is market forces (the demand for loans, and their profitability), and financial regulations, and finally the interest rates set by the central bank.

If a retail bank believes it can turn a profit by lending money borrowed from the central bank, in compliance with the law, it will do so until it exhausts the opportunity. Consumer deposits are irrelevant.

[quantumofmalice]

Exactly. There is no reserve limit: any pretense of that was washed away once sweep accounts became standard.

Banks lend as much as they possibly can, and then a bit more, and then expect the taxpayers to pick up the pieces when it all falls apart.

The irony is that there need not be a reserve ratio: if we just adopted duration-matched banking, where a bank had to demonstrate it had ownership of a given dollar it was lending for the duration it loaned that dollar (e.g. via a CD) it would be fine.

This is the fundamental problem with banking, and I don't understand why no one talks about it. Banks are lying about having money they don't have (i.e. they are promising the same dollar to more than one person at the same time). If we forced them to just stop lying it would all work out, and there wouldn't be any need for a reserve ratio.

[grenoire]

You do realise that the loans banks take are liabilities, right? Banks are risk averse regardless of whether bailouts exist or not.

[quantumofmalice]

> whether bail-outs exist or not

lol

[stephen_g]

As others have said, that is a textbook model of banks that describes how banks haven’t worked for at least a century (if ever?). That’s called the ‘money multiplier’ model, and it’s a myth. Even ‘fractional banking’ isn’t really a valid explanation. How banks work is called ‘endogenous money’, but one economist is trying to change that to the more friendly and self explanatory “bank-originated money and debt.”

The most amazing thing about how banks actually work (see the article) is that they don’t need any deposits to lend. Thus, how much a bank can lend is utterly independent of the amount of deposits they have. (Of course, deposits are useful for liquidity for interbank transfers, but the bank can just borrow reserves from other banks or the CB if it needs). But lending creates deposits with an equal amount of debt.

The other thing to remember is that deposits are a liability to the bank. A bank couldn’t lend out deposits because it wouldn’t balance out in double entry bookkeeping - even if it created the debt as an asset, it needs to create the matching deposit, so now you have two liabilities (deposit lent from, deposit for the person lent to) and one asset (the debt), which doesn’t sum to zero. Whereas creating the asset (mortgage / debt) and a matching liability (deposit) does.

[neilwilson]

Banks are factories for money not warehouses.

Reserves are not even required for banks to function.

A loan creates a deposit and that deposit then moves between people as they pay each other.

Banks can do that until they run out of creditworthy borrowers.

All so callled constraints on banks do nothing other than try to increase the price of lending so there are fewer creditworthy borrowers.

There is no quantity restriction that binds. The payment system would collapse if you tried.

[hidenotslide]

Apparently my answer is worse than the guy who thinks "The fed is literally giving asset holders free money" and the guy who makes a pitch for Bitcoin. Whatever. Utilize your downvote cartel however you see fit I guess.

Regardless of whether the loans are linked to individual deposits or borrowed from other banks, I was just trying to communicate how commercial banks could increase the money supply without input from the central bank. Nowhere did I claim the reserve requirement and monetary base were the limiting factor of the money supply (in fact the last sentence says supply of loans is influenced by interest rates). This is just what figure 1 depicts in the paper. The direct quote from the conclusion of the paper is "Most of the money in circulation is created, not by the printing presses of the Bank of England, but by the commercial banks themselves."

Furthermore I claimed that central banks affect the money supply via rates, which is supported via the conclusion as well: "The Bank of England is nevertheless still able to influence the amount of money in the economy. It does so in normal times by setting monetary policy — through the interest rate that it pays on reserves held by commercial banks with the Bank of England. "