|
|
|
|
|
|
by kilgnad
1197 days ago
|
|
|
If I get a loan from Bank A, then I use that loan to pay a person who deposits the IOU into Bank B. Bank B will go to Bank A and demand the money in cash because it's a competitor bank. If bank A has zero cash on hand they immediately hit a bank run, so basically bank A wants to keep a certain ratio at all times. Thus through the existence of competitor banks, banks are NATURALLY incentivized to keep a reserve ratio. A reserve ratio enforced by law is not necessary in a capitalist economy with healthy competition. Competition prevents banks from going crazy with creating money out of thin air via loans. The removal of the reserve ratio by the government is relatively inconsequential. However this natural regulation through competition is negated by the existence of an entity without competition. The central bank. The central bank functions as an entity that loans money to banks with interest. It is this interest rate that is used to regulate the money supply in the US. Low interest rates are what caused inflation and high interest rates from the central bank are what are now being used to stop inflation. So in this case Bank A can now borrow a bunch of money from the Central Bank thereby increasing it's reserve ratio allowing it to lend more money out. In a sense, the central bank is essentially the entity where the fractional reserve ratio actually matters. The central bank is unregulated so they can print money to loan to other banks however much they like. Thus a bank run on the central bank is impossible. The ratio in this case matters more as a metric that correlates with inflation. |
|
|
What you are describing is pretty close to the free banking eras of eg Scotland and Canada.
> The central bank is unregulated [...]
That's not true. Many central banks have lots of regulations on them. However, they are not regulated by the kind of competition you outlined above.
> [...] The central bank functions as an entity that loans money to banks with interest. It is this interest rate that is used to regulate the money supply in the US. [...]
It's probably more productive to think in terms of the total money supply, and less in terms of interest rates.
For one, loaning money to banks is only one part of what the Fed does. They also outright buy and sell assets (eg in open market transactions). In many instances, the banks (technically) lend money to the Fed by having positive account balances at the Fed.
For a contrasting example on how interest rates don't need to be the focus of monetary policy, have a look at the Monetary Authority of Singapore. Instead of using interest rates as a channel to communicate and effect their monetary policy, they use the exchange rate of the Singapore dollar to a basket of foreign currencies. Crudely, instead of 'setting' the interest rate, they 'set' the exchange rate.
Simplified a bit, they 'set' the exchange rate by standing by to buy and sell Singapore dollar to any comer. They have a printing press, so they can push down the exchange rate as much as they want to, and they also have enough assets to prop it up.
Crucially, this framework doesn't need to worry about any zero bound on interest rates. It works as long as Singapore dollars are worth anything more than zero.