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Hm. Care to qualify your statement? What do textbooks get wrong about money creation?

by bllguo 9y ago

stephen_g 9y ago
A lot of them use the completely invalid 'money multiplier' model, which doesn't follow double-entry accounting rules. Even worse is the high-school kind of 'intermediary model', which imagines that banks lend out the money that people deposit in them. But when a bank creates a mortgage (which is an asset to them), it has to create a corresponding liability (which is the deposit). They can't lend existing deposits out (or any fraction of them), because it would be a liability with a matching liability. This means some surprising things - banks don't actually need any existing deposits at all to lend, and they temporarily create new deposits (which has the same status as 'real' money) when they lend. This money, as well as the debt created at the same time, both disappear as the loan is repaid in equal measure. The way it all works is that because the banks are all transferring a lot of money between themselves, the amount of reserves (and cash, but it's mainly central bank reserves) that they actually need to make payments is only a fraction of the total volume being created and transferred. If they don't have the reserves, they can just borrow them from another bank or the central bank, or on money markets. Of course, it's handy for them for people to deposit money in their bank because it's a cheap way for the bank to get liquidity. This isn't 'fractional reserve' by the way - that comes from the fact that banks in the US are required by the Fed to have a certain minimum amount of central bank reserves (10% of the amount of their deposits). That is just a measure to ensure they have enough liquidity though. The incorrect 'money multiplier model' comes from a misunderstanding of fractional reserve banking. Most countries don't even have a reserve requirement, instead having capital adequacy requirements.

Hm. Care to qualify your statement? What do textbooks get wrong about money creation?

by bllguo 9y ago

Hm. Care to qualify your statement? What do textbooks get wrong about money creation?

A lot of them use the completely invalid 'money multiplier' model, which doesn't follow double-entry accounting rules. Even worse is the high-school kind of 'intermediary model', which imagines that banks lend out the money that people deposit in them. But when a bank creates a mortgage (which is an asset to them), it has to create a corresponding liability (which is the deposit). They can't lend existing deposits out (or any fraction of them), because it would be a liability with a matching liability. This means some surprising things - banks don't actually need any existing deposits at all to lend, and they temporarily create new deposits (which has the same status as 'real' money) when they lend. This money, as well as the debt created at the same time, both disappear as the loan is repaid in equal measure. The way it all works is that because the banks are all transferring a lot of money between themselves, the amount of reserves (and cash, but it's mainly central bank reserves) that they actually need to make payments is only a fraction of the total volume being created and transferred. If they don't have the reserves, they can just borrow them from another bank or the central bank, or on money markets. Of course, it's handy for them for people to deposit money in their bank because it's a cheap way for the bank to get liquidity. This isn't 'fractional reserve' by the way - that comes from the fact that banks in the US are required by the Fed to have a certain minimum amount of central bank reserves (10% of the amount of their deposits). That is just a measure to ensure they have enough liquidity though. The incorrect 'money multiplier model' comes from a misunderstanding of fractional reserve banking. Most countries don't even have a reserve requirement, instead having capital adequacy requirements.