The Fiscal and Monetary Policy Thread - All Things Equalibrium

The Something Awful Forums > Discussion > Debate & Discussion > The Fiscal and Monetary Policy Thread - All Things Equalibrium

Bryter: Nov 6, 2011; but since we are small we may-
uh, we may be the losers

Here's a neat bulletin from the Bank of England for anyone interested in how money is created.

What it boils down to is that banks aren't intermediaries which lend out other peoples deposits. Nor do they "multiply" deposits through the "multiplier effect". When a bank lends money, it simultaneously creates an asset on it's balance sheet (the loan) and a liability (the deposit). Most money is created this way (97% in the UK, slightly lower, I think ~95% in the US).

As it turns out, when you have banks creating money for profit, things can get a bit messy!

http://www.bankofengland.co.uk/research/Documents/workingpapers/2015/wp529.pdf posted:

Economic models that integrate banking with macroeconomics are clearly of the greatest practical relevance at the present time. The currently dominant intermediation of loanable funds (ILF) model views banks as barter institutions that intermediate deposits of pre-existing real loanable funds between depositors and borrowers. The problem with this view is that, in the real world, there are no pre-existing loanable funds, and ILF-type institutions do not exist. Instead, banks create new funds in the act of lending, through matching loan and deposit entries, both in the name of the same customer, on their balance sheets. The financing through money creation (FMC) model reflects this, and therefore views banks as fundamentally monetary institutions. The FMC model also recognises that, in the real world, there is no deposit multiplier mechanism that imposes quantitative constraints on banks� ability to create money in this fashion. The main constraint is banks� expectations concerning their profitability and solvency. In this paper, we have developed and studied simple, illustrative models that reflect the FMC function of banks, and compared them to ILF models. Following identical shocks, FMC models predict changes in bank lending that are far larger, happen much faster, and have much larger effects on the real economy than otherwise identical ILF models, while the adjustment process depends much less on changes in lending spreads. As a result, FMC models are more consistent with several aspects of the data, including large jumps in lending and money, procyclical bank leverage, and quantity rationing of credit during downturns.

# ¿ Oct 11, 2015 09:12

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# ¿ May 16, 2024 00:41

Bryter: Nov 6, 2011; but since we are small we may-
uh, we may be the losers

asdf32 posted:

Although often terribly presented, I don't think the "multiply" model is worth throwing out as it captures certain mechanics and history of banking.

It captures mechanics, but the wrong way around.

The Federal Reserve sure think it's worth throwing out:

http://www.federalreserve.gov/pubs/feds/2010/201041/201041pap.pdf

quote:

We conclude that the textbook treatment of money in the transmission mechanism can be rejected. Specifically, our results indicate that bank loan supply does not respond to changes in monetary policy through a bank lending channel, no matter how we group the banks.

And the BoE working paper above is particularly hard on it:

quote:

In undergraduate textbooks one also finds the older deposit multiplier (DM) model of banking, but this has not featured at all in the recent academic literature. We will nevertheless discuss it later in this paper, because of its enduring influence on popular understandings of banking.

.....

The DM view was widely accepted in academic and policymaking circles between the 1930s and the late 1960s20, and therefore overlapped with the periods during which the FMC and ILF views dominated. In this section we cite leading policymakers and academics who have refuted the DM view, based on a combination of theoretical, institutional and empirical arguments.

The fact that the creation of broad monetary aggregates by banks comes prior to and in fact may (if commercial banks need more reserves) cause the creation of narrow monetary aggregates by the central bank is acknowledged in many descriptions of the money creation process by central banks and other policymaking authorities. The oldest and clearest comes from Alan Holmes (1969), who at the time was vice president of the New York Federal Reserve: �In the real world, banks extend credit, creating deposits in the process, and look for the reserves later.� This is exactly the view put forward in this paper. Ulrich Bindseil (2004), at the time head of liquidity management at the European Central Bank: �It appears that with RPD [reserve position doctrine, i.e. the money multiplier theory] academic economists developed theories detached from reality, without resenting or even admitting this detachment.� Charles Goodhart (2007), the UK�s preeminent monetary economist: �... as long as the Central Bank sets interest rates, as is the generality, the money stock is a dependent, endogenous variable. This is exactly what the heterodox, Post-Keynesians ... have been correctly claiming for decades, and I have been in their party on this.� Borio and Disyatat (2009), in a Bank for International Settlements working paper: �In fact, the level of reserves hardly figures in banks� lending decisions. The amount of credit outstanding is determined by banks� willingness to supply loans, based on perceived risk-return trade-offs and by the demand for those loans.� Disyatat (2010), again from the BIS: �This paper contends that the emphasis on policy-induced changes in deposits is misplaced. If anything, the process actually works in reverse, with loans driving deposits. In particular, it is argued that the concept of the money multiplier is flawed and uninformative in terms of analyzing the dynamics of bank lending.� Carpenter and Demiralp (2010), in a Federal Reserve Board working paper: �While the institutional facts alone provide compelling support for our view, we also demonstrate empirically that the relationships implied by the money multiplier do not exist in the data ... Changes in reserves are unrelated to changes in lending, and open market operations do not have a direct impact on lending. We conclude that the textbook treatment of money in the transmission mechanism can be rejected...�. William C. Dudley (2009), president of the New York Federal Reserve Bank: �... the Federal Reserve has committed itself to supply sufficient reserves to keep the fed funds rate at its target. If banks want to expand credit and that drives up the demand for reserves, the Fed automatically meets that demand in its conduct of monetary policy.� European Central Bank (2012), May 2012 Monthly Bulletin (emphasis added): �The occurrence of significant excess central bank liquidity does not, in itself, necessarily imply an accelerated expansion of ... credit to the private sector. If credit institutions were constrained in their capacity to lend by their holdings of central bank reserves, then the easing of this constraint would result mechanically in an increase in the supply of credit. The Eurosystem, however, ... always provides the banking system with the liquidity required to meet the aggregate reserve requirement. In fact, the ECB�s reserve requirements are backward-looking, i.e. they depend on the stock of deposits (and other liabilities of credit institutions) subject to reserve requirements as it stood in the previous period, and thus after banks have extended the credit demanded by their customers.� Finally, academic critiques of the deposit multiplier model also exist (Kydland and Prescott (1990), Brunner and Meltzer (1990), Lombra (1992)), although recently this issue has received much less attention due to the disappearance of monetary aggregates from modern monetary models.

# ¿ Oct 14, 2015 19:53

Bryter: Nov 6, 2011; but since we are small we may-
uh, we may be the losers

asdf32 posted:

Well it's fine to discard existing models for better ones. I'd just note that in this case it's not just a model, it's also history.

If you take the multiplier to mean that there's a hard limit on money/credit creation, I don't know that that's really ever historically been the case though. Concerns about solvency and profitability always seem to be the limiting factor. The destabilising effects of this on the money supply have been recognised for quite some time, and in Britain led to the passage of the Bank Charter Act 1844, which prohibited banks from issuing their own currency. This obviously didn't account for the fact that deposits work in basically the same way, and although money wasn't virtual in the modern sense, deposits could be created with a stroke of a pen, and the money moved around via cheques, essentially meaning banks retained their ability to create money.

Funnily enough, in 2010, the Governor of the Bank of England acknowledged that the purpose of the act had been undermined and expressed sympathy with the idea of forcing banks to conform to it (i.e. an end to fractional reserve banking). Probably not going to happen any time soon in Britain, but it could be in Iceland.

# ¿ Oct 16, 2015 11:23

Bryter: Nov 6, 2011; but since we are small we may-
uh, we may be the losers

This doesn't necessarily show "support" from those who disagree, but...

# ¿ Oct 16, 2015 12:27

Bryter: Nov 6, 2011; but since we are small we may-
uh, we may be the losers

Yoshifan823 posted:

he wants to re-enact Glass-Steagal

Does he give a reason why?

# ¿ Oct 17, 2015 09:08

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# ¿ May 16, 2024 00:41

Bryter: Nov 6, 2011; but since we are small we may-
uh, we may be the losers

asdf32 posted:

The multiplier doesn't imply a hard limit. The basic 1/R equation for fractional reserve money creation which textbooks love to present [even though that type of mathematical precision is irrelevant] allow near infinite money creation if you're willing to have tiny reserves. So of course solvency and profitability are the limits.

Taking reserve ratios into account, I mean.

Yoshifan823 posted:

Basically as a sort of bank antitrust measure, so you don't have an entity (or small group of entities) that is controlling banking so much so that the general public is hurt, and smaller local/regional banks don't have a significant disadvantage.

Seems like re-enacting the McFadden Act would do a better job of that.

I really don't know what to make of the push for Glass Steagall. I don't think it would be a bad thing per se, but I sort of worry that it's the end goal for a lot people pushing financial reform, despite the fact that there's a lot it wouldn't address.

Bryter fucked around with this message at 07:33 on Oct 18, 2015

# ¿ Oct 18, 2015 06:35

The Something Awful Forums > Discussion > Debate & Discussion > The Fiscal and Monetary Policy Thread - All Things Equalibrium