Vorbemerkung für deutschsprachige Besucher (Preface for German-language visitors):
Der vorliegende Text ist (wie bereits der vorangegangene Blott) aus einem Mailwechsel mit dem US-Soziologen John Bradford, Assistant Professor and Coordinator of Sociology, Mississippi Valley State University, hervorgegangen und daher auf Englisch verfasst.
Prof. Bradford war es auch, der mich auf das hier (hauptsächlich) behandelte Papier (Nr. 2) der englischen Zentralbank zum Thema Geldschöpfung hingewiesen hat.
The current blog post is part of an ongoing email-exchange with John Bradford, Assistant Professor and Coordinator of Sociology, Mississippi Valley State University, on the subject of money (creation etc.). I am grateful to prof. Bradford for calling my attention to the BoE paper on money creation (no. 2) which is the (main) subject of the following remarks.
In its Quarterly Bulletin 2014 Q1 the Bank of England is trying to clean up a mess of myths about money, in particular about how money is created (nowadays).
Two papers tackle this subject:
- "Money in the modern economy: an introduction" By Michael McLeay, Amar Radia and Ryland Thomas of the Bank’s Monetary Analysis Directorate. [Henceforce also quoted as "Introduction".]
- "Money creation in the modern economy" by the same authors. [Henceforce also quoted as "Money creation".]
As for the first paper, I will restrict my comment to the chapter "Money is an IOU" (p. 6).
There the authors claim:
rather than all on payday. These patterns of demand mean some people wish to borrow and others wish to hold claims — or IOUs — to be repaid by someone else at a later point in time. Money in the modern economy is just a special form of IOU, or in the language of economic accounts, a financial asset."
This description does not help us to understand how money is created, nor how it functions. And calling money an "IOU" is plain wrong.
In the banks' books, customer deposits are liabilities, and when a central bank issues money (called base money, central bank money or high powered money etc., see also Wikipedia keyword "Monetary base") it is entered in the balance sheet as a claim of the banks (against their customers) and as a liability (to the customers - unless these have transferred the money to another bank).
But these bookkeeping-practices do not tell us anything about how money functions in the economy and, in fact, not even about the different ways how money can be created. In greater detail I have treated these questions in my previous blogpost "Time to say goodbye: To slipshod definitions of "money" in economics!", so here a few remarks on the subject must suffice.
Whoever holds money may or may not owe something to others (persons or, typically, banks). It is utterly misguided to call money an IOU because this might give the (wrong) impression that money-holders owe something to others. And therefore, that the rich are poor folks after all, because by holding money they owe something to others. In reality, of course, other people (and companies, and the state) owe money to them.
At any rate, the inappropriate definition of money as an "IOU" may well be popular for a cause, namely to obfuscate the position of the haves vs. the have-nots. (Which does not mean that whoever uses this definition is intentionally trying to misinform people.)
Any meaningful definition of money must try to catch what money does in the economy, and must be aware that the functional dimension of money is different from the dimension of money creation.
Modern money is commonly issued as credit (by banks - henceforth, "banks" will stand as shorthand for "commercial banks" unless otherwise stated - or central banks). But not all of it.
Coins are minted and simply spent by the government. Economically, this is a kind of taxation: in principle, whenever money is simply being "printed" (or minted), the issuer can "pay" (or in terms of the real economy: take out goods from the social product) with this money without himself giving something in return.
Depending on the relative size of such practices, government money-printing may have serious inflationary consequences (example: German Hyperinflation in 1923).
Since 94% of the currency in circulation are bank notes, and those are being brought into circulation by way of credit, coins only amount to 6% (p. 8, footnote 4 of paper 1, p. 15, footnote 5, of paper 2), the inflationary effects of this 'government freeloading' on prices are at most minimal.
Obviously, when money is created by credit the borrower is obliged to pay it back to the bank (or to the central bank; but only banks, and in some cases the government, have access to central bank credit) sooner or later. So he owes the money (plus interest) he has borrowed to the bank. Or, to put it differently: the bank hands out the money (which is NOT an IOU!) against the "IOU" of the credit contract.
Loosely speaking it may be okay to regard money as an IOU for the borrower. (Instead of "borrower" I would call him, in the context of money creation, the "first money receiver", "first money holder" or, considering what he will do with the money, "first shopper").
But even for the first money holder the money (credit) itself must be distinguished from the obligation to pay it back to the bank (credit contract or IOU).
And when he spends it, then certainly the "second (ff.) money holder" does not owe anything to anybody. Instead, "the market" "owes" him (de facto, not legally!) the delivery of goods whenever he decides to spend the money. So for sure when the money has traveled to the 2nd (ff.) receiver, the term "IOU" is no adequate description of the money he holds.
Of course, more likely than not he will deposit his money with a bank (until he spends it). And the bank is obliged to give it back to him, whenever he wishes (sight deposit) or at a certain date (time deposit or term deposit).
But this contractual relation between a bank and a depositor has nothing to do with the essence of money. The money holder might stash the cash under his pillow, and it would still be money. Therefore, defining how money appears in the bank books (namely as an "IOU") does not yield any information about the economic function of money, nor about the way it could have been created (the depositor could have delivered coins, which are not credit created).
The second paper* does dispell some stubbornly persistent narratives, namely that banks, when lending out money, lend their customers deposits and/or their reserves.**
These myths have been refuted by economists for quite some time. But they still live and prosper, and seemingly even in the minds of such famous economists as Paul Krugman (cf. this summary of his debate with Steve Keen). As an indication of the tenacity of such beliefs I take the fact that Paul Sheard, Chief Global Economist and Head of Global Economics and Research of the US-rating agency Standard & Poor's, felt obliged in August 2013 to write an essay "Repeat After Me: Banks Cannot And Do Not 'Lend Out' Reserves" on the subject.
* [Unless otherwise stated, quotations in this section refer to the "Money creation" paper.]
**[Actually, if one includes currency, banks DO lend out reserves. But only this type and, since borrowers rarely take out cash, probably only a minuscule amount of it. Of course, depositors will also withdraw cash, but that has nothing to do with bank lending.]
However, it appears that such a clarification has not yet come from any central bank, or at least not so distinctly. For whichever reasons (did they think it's irrelevant, what the public thinks about money creation? Or did they hold it to be more convenient to practice their seeming monetary magic under the eyes of uninformed or misinformed spectators?) they obviously have preferred not to unveil, or admit to, what has been obvious to serious observers for several years, if not decades.
Still, the paper leaves room for clarification and completely blocks out fundamental questions, in particular about the role of collateral in the creation of reserves.
So let me try to approach things from a different perspective and point out where I have problems with the BoE-depiction of credit creation.
The basic bottleneck in banking (i. e. credit creation) is base money (central bank money, high powered money - HPM).
The BoE-papers pay tribute to this fact in stating "Base money is important because it is by virtue of their position as the only issuer of base money that central banks can implement monetary policy" (p. 7 "Introduction"-paper)
Banks hold base money in the form of reserves. The Wikipedia entry on "bank reserves" informs us that "Bank reserves are banks' holdings of deposits in accounts with their central bank (for instance the European Central Bank or the Federal Reserve, in the latter case including federal funds), plus currency that is physically held in the bank's vault (vault cash)".
This makes sense, since currency can always be traded in for deposits with the central bank and vice versa. However, the BoE-papers distinguishes between "reserves" (meaning bank deposits with the central bank) and currency held by the banks. (E. g. fig. 1, p. 16).
At any rate, both currency and deposits with a central bank are base money. They are the basis which the banks need in order to create their own "bank money".
This term does not appear in either paper and does not seem to be officially used. The Wikipedia article "Demand deposit" equates these deposits with "bank money":
"Demand deposits, bank money or scriptural money are funds held in demand deposit accounts in commercial banks. These account balances are usually considered money and form the greater part of the narrowly defined money supply of a country."
Obviously, under this definition, base money would be included in the amount of "bank money." The technical term for this is "broad money": "Broad money is made up of bank deposits — which are essentially IOUs from commercial banks to households and companies — and currency — mostly IOUs from the central bank" (p. 15).
In my first version I had erroneously gone by the assumption that broad money includes bank reserves (in the broader sense, i. e. account holdings with the central bank plus cash in banks' vaults). However, from re-reading the BoE-papers I conclude that "broad money" does NOT include reserves proper nor currency held by banks (for this, cf. annotation d. to chart 1 of the "Introduction" paper).
As for the percentage of reserves (including cash) vs. deposits I've found these statistics from the American Federal Reserve System (Fed). Not sure whether I'm reading them right, but to me it looks like the banks have some 12,5 trillion dollars (H.8; Page 3 on this sheet, data for mid-march 2014) liabilities. Reserve balances stood (again: if I'm reading this sheet correctly) at 2,5 trillion dollars. If true, deposits (some 10 trillion) and a few other liabilities would only be ca. 5 times the amount of reserves. This should make the the leverage of central bank money policy pretty much effective - provided, the banks really need those reserves. If a large part is being held just to be on the safe side, things may look different.
(As for Great Britain, the proportions in Chart 1 of the "Introduction" paper, p. 11, suggest a ratio of something like 1 : 6, which would be in the same dimension as the US-data.)
[However, because the monetary base has gone up sharply during the financial crisis in autumn 2008 and stayed high ever since, banks must have accumulated large excess reserves. So in normal times the ratio of bank reserves and cash vs. bank deposits is perhaps something like 1 : 10 - 20 or so.]
On paper, banks can create unlimited amounts of "bank money" (see my "OBaNoCa model of money creation and interest in the real economy" - English text at the end - for an environment with a monopoly bank and no currency). In practice, there are a number of technical, economic and regulatory restrictions. These are largely identified in the "Money creation" paper (chapter "Limits to broad money creation", p. 17 ff.). However, the most important obstacle on the technical level (actual payment to the customer or to another bank) is not directly adressed: Reserves.
The following factors reduce the banks' need for reserves in transactions:
- remittances between customers of the same bank,
- clearing procedures (netting) between banks and
- interbank-lending.
Nevertheless, as we can infer from the data given above, they still need quite a high portion of reserves in order to create credit deposits.
The authors rightly refute the opinion that "the amount of reserves ... [is] a binding constraint on lending" (p. 15, emphasis added).
But they pretty much dither about the impact of reserves (money in bank accounts with the central bank) on credit creation.
On the one hand, they state:
"The amount of bank deposits ... influences how much central bank money banks want to hold in reserve (to meet withdrawals by the public, make payments to other banks, or meet regulatory liquidity requirements), which is then, in normal times, supplied on demand by the Bank of England" (p. 15, emphasis mine).
- from "But banks need reserves (NOT deposits) to lend" (original version, emphasis added)
- to "But banks need reserves (AND deposits) to lend" (revised version, emphasis added)
My shift of opinion is the result of some further thoughts on the process of bank lending, i. e. on whether banks lend money that exists, or whether they create money when lending. Leaving equity, cash holdings or reserves etc. aside, we can visualize the process of bank credit creation and money creation in the following -3- simple models:
Model I (credit granted, money transferred to customer of same bank):
- Step 1: "Credit bank" starts with two customers (C/A and C/B) which have opened up accounts without deposit (individual account balance zero)
- Step 2: C/A borrows 1.000,- (of whichever currency). Account balance C/A + 1.000,-.
- C/A transfers the money to C/B, i. e. to a customer of the same bank . Result for the credit-bank: Debit the accound of C/A and credit the account of C/B. In-house transaction, no (base) money needed, it's just a bookkeeping-operation.
Model II (credit granted, money transferred to customer of another bank):
- as above
- as above
- C/A transfers the money to a customer of another bank ("receiving bank customer" = R/A). Credit bank needs 1.000,- base money, because it cannot pay another bank with its self-created bank-money. Let's assume credit bank can borrow the amount from the receiving bank. Then, in a non-technical sense, receiving bank is "depositing" 1.000,- with credit bank. (Alternatively, we could assume that another custumer, C/C, had in the meantime deposited 1.000,- with credit bank. In this case, no interbank-borrowing would be necessary.) At any rate: In this variant of model I the credit bank needs either base money (i. e. "reserves") (if we vary our model building and assume that the credit bank DID have reserves) or a deposit (in this case: lending from another bank as an equivalent to deposits) to lend. If (like in our model) the interbank-lending takes place directly between the credit bank and the receiving bank, no transaction of base money is involved.
- Banks do (not) need to have reserves before they can lend or
- Banks do (or do not) need reserves as a consequence of lending
Model III (credit granted, mutually offsetting customer transactions):
- Two parallel steps: credit bank and receiving bank both lend 1.000,- to a customer (C/A and R/A).
- Two parallel steps: C/A makes transfer to customer C/R with receiving bank, R/A makes transfer to customer with credit bank.
- Consequence for both banks: Transfers balance out. Due to clearing, no (base) money is required for the mutual remittances. But this result is due to the fact that both banks have gained new deposits from the outside. No actual transfer of base money (reserves) was involved. Nevertheless, both deposits are in principle base money deposits (= "reserves" for the banks): had the banks themselves created these deposits by making more loans, it would have been of no use for them. So while the banks in this case did not actually need reserves (because of the netting procedure in clearing), the certainly DID need deposits in order to be able to lend. In this model, the banking system has actually self-produced the money, here deposits substitute reserves, because the mutual remittances even out.
So when we get down to the nitty-gritty, things are far more complicated than simple phrases like "banks do not lend reserves/deposits" suggest.
What's the bottom line of all those processes in banking which our foregoing models have isolated, how do we best summarize our findings? Probably in a phrase similar to my heading:
"Banks do not lend reserves or deposits. But banks need reserves and/or deposits to lend."
Of course, while this is a neat definition, it doesn't tell us anything about the quantities needed, or the exact time when they are needed in the credit creation process. Here model building reaches its limits; maybe empirical research can solve (or approximate a solution to) those questions. But the figures I have dug out above suggest a surprisingly high reserve ratio.
One thing that the models do show: In its internal relations, the banking system could in theory completely do without base money.
However, this is needed because customers sometimes do withdraw cash. And in reality also because banks do not always cooperate quite as trustingly as model II presupposes; sometimes reserves ARE needed to make interbank-payments.
Seen in this light it is rather amazing that central banks should be able to substantially influence interest rates at all.
At any rate, the BoE is quite confident that central banks can actually influence the interest rate, and thereby the amount of money in the economy. In the following quotations "Bank of England" can be replaced by "central bank", because obviously the authors hold this to be true for central banks in general (emphases added):
"A number of factors influence the price of new lending, not least the monetary policy of the Bank of England, which affects the level of various interest rates in the economy" (p. 17),
"The ultimate constraint on money creation is monetary policy" (subheading p. 17),
"By influencing the level of interest rates in the economy, the Bank of England’s monetary policy affects how much households and companies want to borrow. This occurs both directly, through influencing the loan rates charged by banks, but also indirectly through the overall effect of monetary policy on economic activity in the economy. As a result, the Bank of England is able to ensure that money growth is consistent with its objective of low and stable inflation" (p. 17/18),
"Interest rates on both banks’ assets and liabilities depend on the policy rate set by the Bank of England, which acts as the ultimate constraint on money creation" (p 18),
"Monetary policy — the ultimate constraint on money creation" (subheading p. 17/18)
"In normal times, the Monetary Policy Committee (MPC), like most of its equivalents in other countries, implements monetary policy by setting short-term interest rates, specifically by setting the interest rate paid on central bank reserves held by commercial banks. It is able to do so because of the Bank’s position as the monopoly provider of central bank money in the United Kingdom. And it is because there is demand for central bank money — the ultimate means of settlement for banks, the creators of broad money — that the price of reserves has a meaningful impact on other interest rates in the economy (p. 20/21),
"The Bank of England controls interest rates by supplying and remunerating reserves at its chosen policy rate. The supply of both reserves and currency (which together make up base money) is determined by banks’ demand for reserves both for the settlement of payments and to meet demand for currency from their customers — demand that the central bank typically accommodates" (p. 21),
and, in the Conclusion on p. 25:
"... in contrast to descriptions found in some textbooks, the Bank of England does not directly control the quantity of either base or broad money. 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. More recently, though, with Bank Rate constrained by the effective lower bound, the Bank of England’s asset purchase programme".
The remainder of the paper (p. 21 ff.*) is dedicated to a description of how the central bank thinks its monetary policy of "quantitative easing" (QE) works:
"QE involves a shift in the focus of monetary policy to the quantity of money: the central bank purchases a quantity of assets, financed by the creation of broad money and a corresponding increase in the amount of central bank reserves. The sellers of the assets will be left holding the newly created deposits in place of government bonds. They will be likely to be holding more money than they would like, relative to other assets that they wish to hold. They will therefore want to rebalance their portfolios, for example by using the new deposits to buy higher-yielding assets such as bonds and shares issued by companies — leading to the ‘hot potato’ effect discussed earlier. This will raise the value of those assets and lower the cost to companies of raising funds in these markets. That, in turn, should lead to higher spending in the economy."
* [Besides a box explaining on p. 22/23 "The information content of different types of money and monetary aggregates".]
So the basic idea is to boost or (as part of the Fed-policy towards the US housing crash) to sustain an asset prices, i. e. to prop up the market value of assets (real estate, stocks etc.). This is supposed to have to effects (my interpretation; a central bank certainly would not put it so bluntly):
- On the side of sentiment, it will make owners feel richer and thereby induce them to spend more.
- On the side of finance, it will boost the market and ramp up the hypothecary value of properties or loan value of stocks etc. This in turn will at once enable and induce owners to take out more or higher loans, and spend money more lavishly.
I am not the only one to be critical about this strategy to purportedly restore economic health. Haven't read it yet, but William R. White's 2012 paper "Ultra Easy Monetary Policy and the Law of Unintended Consequences" goes probably in this direction. And so does, on a more popular level, Christopher Lingle's article "Consumption Can Drive Economic Growth? The Misconception Is Deeply Entrenched" (part of a series "IT JUST AIN'T SO").
The American (British, and other) housing boom had lead to a distortion in the price structure. In relation to income, houses costed a lot more during the boom than on average in the past. In the long run, any such distortion cannot be without consequences for the ability of borrowers to pay back their credits.
QE is about market value. However, at the end of the day and seen over the whole economy, it's not the level of market prices that generates installments, but income. The obsessment of (in particular: anglo-saxon) central banks with market-prices may well be counterproductive for the development of the real economy. It encourages speculation and jacks up profits in a financial "industry" which is dysfunctional in relation to the real economy. In general, this sort of monetary fire fighting favours speculation over hard work. Not surprisingly, it is perfectly in line with the ideas that Irving Fisher - respected economist, but also failed speculator - presented in his 1933 "Debt-Deflation Theory of Great Depressions". His paper is basically a "proof" that central banks must underpin whatever asset prices the markets have reached with an adequate supply of money. If not, many loans based on on the recoverability of these prices will go bust.
Of course the dimension of any potential market rigging by way of monetary policy depends on the size of such activities. For all I know in the States the Fed did by some housing loans from banks, but not on a gigantic scale.
Most (in Great Britain: all - ?) of QE-money has gone into the purchase of government bonds. The authors don't mention it but this is not just about any reshuffeling of private portfolios. Instead, both central banks have bought huge amounts of government debt. Ben Bernanke has described the intended effects of this policy in his 'helicopter speech' "Deflation: Making Sure 'It' Doesn't Happen Here" already in 2002 (emphases added):
"Fiscal Policy
Each of the policy options I have discussed so far involves the Fed's acting on its own. In practice, the effectiveness of anti-deflation policy could be significantly enhanced by cooperation between the monetary and fiscal authorities. A broad-based tax cut, for example, accommodated by a program of open-market purchases to alleviate any tendency for interest rates to increase, would almost certainly be an effective stimulant to consumption and hence to prices. Even if households decided not to increase consumption but instead re-balanced their portfolios by using their extra cash to acquire real and financial assets, the resulting increase in asset values would lower the cost of capital and improve the balance sheet positions of potential borrowers. A money-financed tax cut is essentially equivalent to Milton Friedman's famous "helicopter drop" of money. Of course, in lieu of tax cuts or increases in transfers the government could increase spending on current goods and services or even acquire existing real or financial assets. If the Treasury issued debt to purchase private assets and the Fed then purchased an equal amount of Treasury debt with newly created money, the whole operation would be the economic equivalent of direct open-market operations in private assets."
Tricks like these may mitigate an economic crisis for a while. But at one point or another the money that was 'dropped from a helicopter' will have to be picked up by that very same copter, i. e. the government will have to raise taxes in order to recollect the money that it has spent in advance. If not, the extra money should in principle lead to (more or less, depending on the amount) inflation. Either way, the spending spree will come at a cost.
Overall I am left with the impression that central banks tend to consider every problem as a (credit) nail, because all they have is the hammer of (base) money creation.
Basically, they try to cure the financial-economic crisis with "more of the same": Credit channel is broken? Let's try to open up another one, or find other ways to push credit on people. Who knows: maybe there still are some folks out there who can bear more borrowing?
Above, I have demonstrated how central bank thinking is skewed when discussing the erroneous definition of money as an IOU.
This idea seems to be associated with an economic world view dominated by double-entry accounting, where everything is nicely balanced.
In this respect, the presentations at the top of page 19 are treacherous. Of course they are highly generalized, but it simply is utterly implausable to present the assets of natural persons as commonly being offset by liabilities.
Of course when someone buys a house, and finances it with a loan, this is a financial liability corresponding (more or less) to the price of the house.
But apart from this, i. e. before the purchase, there is no reason to assume that his other assets are burdened with any liabilities.
Equally, the seller of the house may or may not have bought it with a mortgage. But once he has sold it (and received the money) he will redeem his own home loan (if he had any) and afterwards be free from liabilities.
This distortion does not make any difference for the purpose of the authors, which is to explain money creation in a tangible model. But it does make an impact on the mindset of the readers (and reflects that of the writers). The message is the same as in the faulty definition of money as an IOU: Whoever has money must have debts. But we all know, that this just ain't so.
And this imbalanced distribution - some owning money, many others owing it - is very likely the root cause of the financial crisis of 2007 ff.: Overaccumulation on the one side, and underconsumption on the other.
I'm not implying that the authors are intentionally trying to cover up the economic importance of this disequilibrium but I am sure that this result is not accidental. The interest of the money holders is so deeply ingrained in the economic discourse, that subconsciously it sneaks in everywhere.
Whether or not any such distortion of reality is intentional, or crucial to the argument, we should try to perceive and rebut it.
Central banks seem to be obsessed with lending - because that is what they may be able to influence. But all this 'channel-magic' of monetary policy to me looks a lot like Voodoo raindances.
No use to push up lending, when there isn't enough spending - by the money-owners.
Because whether or not borrowers can pay back the loans eventually depends on whether the "second (ff.) money receivers" are willing to spend it. Instead of storing it in their bank deposits.
I very much doubt that in the longer run our economy will actually be better off with a monetary policy which in my assessment tries to replace the spending gap by a credit trap.
Addenda April 5, 2014
Julien Noizet, the blogger behind "Spontaneous Finance", has written a blog post supporting in effect the argument that I have made above: that reserves DO matter after all:
"A response to Scott Fullwiler on MMT banking theory". (Jan. 14, 2014): "The endogenous money theory correctly assumes that the lending decision regarding a single loan is independent of the reserve status of the bank. However, the theory incorrectly assumes that this description also applies to lending as a whole." ..... "The fallacy of composition involves applying this reasoning to a bank’s aggregate lending. What happens as a one-off event cannot happen continuously ...".
This was followed by a second entry (Jan. 16, 2014) under the heading "The central bank funding stigma". There, Noizet refers to a post on the blog of the Federal Reserve Bank of New York "Why Do Banks Feel Discount Window Stigma?" by Olivier Armantier (Jan. 15, 2014), which in turn summarizes the results of a study "Discount Window Stigma during the 2007-2008 Financial Crisis" by Olivier Armantier, Eric Ghysels, Asani Sarkar, and Jeffrey Shrader (Jan. 2011, revised Sept. 2013).
Also relevant in this context is Noizet's entry from March 30, 2014, under "More inside/outside money endogeneity confusion". There he makes some important points (emphases added):
"Let’s clarify something: the fractional reserve banking/money multiplier model necessarily implies endogenous creation of bank inside money. It describes how banks multiply the money supply from a small amount of externally-supplied reserves. If this isn’t endogenous creation, I have no idea what this is." .....
"The recent debate wasn’t about whether bank inside money was endogenously created but about whether or not the monetary base (i.e. outside money, or bank reserves) was also endogenously created. This is not at all the same thing and has very different implications altogether. If the monetary base is endogenously created, the central bank cannot control the money supply, as MMTers and some post-Keynesians believe. I believe this is not the case ...". .....
"... if bank inside money is endogenously created and outside money exogenously created, this can only mean one thing: banks’ inside money creation ability is exogenously constrained by the amount of outside money in the system ...". (Sounds logical!)
Also, Noizet is trying to save, to some extent (and with convincing reasons), the money multiplier theory:
"In their attempt to attack the money multiplier theory, they mistakenly say that the theory assumes a constant ratio of broad money to base money. There is nothing more wrong. What the money multiplier does is to demonstrate the maximum possible expansion of broad money on top of the monetary base. The theory does not state that banks will always, at all times, thrive to achieve this maximum expansion. I still find surreal that so many clever people cannot seem to understand the difference between ‘potentially can’ and ‘always does’." [He took this quotation from his own former blog post on the BoE-paper.]
(Personally though, instead of bickering over what the money multiplier theory "does" assume or not, I would prefer to talk about how this theory makes sense - and how not.)
Directly about the BoE-paper is his article "The BoE says that money is endo, exo… or something". Extracts:
"Contrary to what some seem to believe, the BoE does not endorse a fully endogenous view of the monetary system, and certainly not an MMT-type endogenous money theory."
This is for (or rather: against) gold-money-fetishists:
"First, there seems to be an absolute obsession with differentiating the ‘modern’ from the ‘pre-modern’ banking and monetary system. The paper keeps repeating that "in reality, in the modern economy, commercial banks are the creators of deposit money". (page 2)
Well… You know what, guys? It was already the case in the pre-fiat money era… Banks also created broad money on top of gold reserves, thereby creating deposits, the exact same way they now do it on top of fiat money reserves. The only difference is the origins of the reserves/monetary base."
"The point that “saving does not by itself increase the deposits or ‘funds available’ for banks to lend” (page 2) is slightly misinterpreted. By not saving, and hence, consuming, customers are likely to maintain higher real cash balances, leading to a reserve drain. Moreover, even if no reserve drain occurs, banks end up with a much less stable funding structure, that does not make it easier to undertake maturity transformation. It is always easier to lend when you know that your depositors aren’t going to withdraw their money overnight."
"... the BoE economists once again contradict themselves, when [they explicitly refute the money multiplier theory, but] on pages 3 and 5 to 7 they essentially describe a pyramiding system akin to the money multiplier theory." [I had described this by saying "[the authors refute the opinion that reserves are a binding constraint on lending, but they] pretty much dither about the impact of reserves (money in bank accounts with the central bank) on credit creation].
"The ‘banks lend out their reserves’ misconception is itself misconceived. I strongly suggest those BoE economists to read my recent post on this very topic. Here again this is in opposition with their later point that individual banks can suffer reserve drains and withdrawals through overlending…".
That contradiction which Noizet has identified is exactly what I meant when talking about some "dithering" in the BoE-paper.
Scott Sumner has commented on the BoE-paper under "Banking theory disguised as monetary theory?"
(March 13, 2014). There he makes an interesting assertion on terminology (emphasis mine):
"Lots of people use the term ‘reserves’ when they would be better off using the term ‘monetary base.’ Back in 2007 the part of the US monetary base that was “coins” was larger than “bank reserves.” So it would have been more accurate to talk about central banks injecting coins into the system. And prior to 2008 new base money mostly flowed out into currency in circulation within a few days, even if the first stop was the banking system."
I guess I myself have been guilty of this confusion, so please read my blog post with this clarification in mind. (However, I have been trying to make it clear whether I refer to reserves proper, or reserves plus currency. So in essence, if not in terminology, it should be clear what I am referring to in any given situation.)
Interesting in the context of my discussion is also the following passage, which refers to the BoE-claim "One common misconception is that banks act simply as intermediaries, lending out the deposits that savers place with them" (emphasis added):
"I recall that once when Krugman was faced with this sort of argument he said something to the effect of “it’s a simultaneous system.” Banking is an industry that provides intermediation services. Banks have balance sheets with assets and liabilities. It makes no sense to say that one side of the balance sheet causes the other. If people want to borrow more, then bank interest rates on loans and deposits adjust in such a way as to provide a new equilibrium, probably with a larger balance sheet. But that’s equally true of the situation where people want to hold larger amounts of bank deposits. It’s completely symmetrical. Consider the real estate broker industry. Does more people buying houses cause more people selling houses, or vice versa?"
And another one about the money multiplier (emphasis added):
"I’m not a fan of the money multiplier model, but it’s sometimes unfairly maligned. Textbooks don’t treat it as a constant, any more than they treat velocity or the fiscal multiplier as constants. They may do an example where it is constant, but then they discuss reasons why it changes. The real problem here is “binding constraint.” [What I have said before.] In economics there are almost never binding constraints on anything."
In "The money multiplier is dead" Frances Coppola informs us about the relative position of the paper in the official description of money creations by central banks in the past (emphasis added):
"To be sure, numerous papers from many eminent researchers and august institutions (including the Fed, the IMF, the ECB and the Bank for International Settlements) have cast doubt upon conventional theory as an adequate explanation of money creation in a modern fiat money system. But to my knowledge this is the first time that a central bank has presented an explanation of money creation that so comprehensively departs from conventional orthodoxy."
"The (commercial) banking system may have the ability to create money, but that does not mean that banks can drive up the supply of money and credit without constraint. The granting of loans and creation of money are limited by the banking system’s interaction with non-banks and the central bank, by regulations and, not least, by banks’ own inherent interest in profit maximisation.
One such constraint is the need for banks to fund the loans they create. Deposits play a major role in this regard, for while banks have the ability to create money – that is, to accumulate a stock of assets by originating liabilities themselves in the form of sight deposits – they need funding in the form of reserves."
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