3 ms·

> The truth is the bank created $5 in loans, and through that $5 in deposits. But for that the bank needs to hold $1 (or whatever) in reserves, so either they

by kgwgk 7y ago

> The truth is the bank created $5 in loans, and through that $5 in deposits. But for that the bank needs to hold $1 (or whatever) in reserves, so either they had excess reserves already (because “someone gave them $1, the bank can now lend $5”) or they a) get new deposits, b) get them from another bank (i.e. the money comes from previous deposits elsewhere) or c) new money is created by the central bank.

JumpCrisscross 7y ago
The loans are created first. At the end of the day, if reserves are inadequate, they are borrowed. This creates the overnight interbank market. Because a dollar dealt results in a deposited, this system is self-reinforcing.
- kgwgk 7y ago
  But this is not really different from the standard description: you deposit an incremental $1 (cash or a loan) into the banking system and the banking system can loan out $5 (edit: in fact, 0.9$ at first) when it decides to do so. Banks can create this new money “multiplying” deposits (or the central bank intervention is required to create “extra” money).
  - JumpCrisscross 7y ago
    > this is not really different from the standard description It is. It’s the difference between picturing a rocket propelled by expanding gases versus a vessel thrust forth by Newtonian dynamics. It is correlation versus causality. Loans cause deposits. Deposits correlate with loans. This discrepancy is the source of money supply estimation error. $1 deposited doesn’t create $5 in loans. $5 in loans prompts about $1 in reserves. The difference in these models explains the interbank market, per se and in terms of rates; reserves as a stochastic versus deterministic phenomenon; bank runs and much more. Loans create deposits. Not the other way. Modern banking makes sense once you internalise this difference.
    - kgwgk 7y ago
      If your point is that the actual money issued by the central bank (M0) does not necessarily result in the monetary supply that could be potentially produced according to the minimal reserve requirements that’s obviously true. Banks are not forced to loan out as much as they could, they have a choice. And because the system is not working at “full capacity” the central bank cannot control the money supply adjusting the minimal reserve requirements. They use other mechanism like short term rates (including through the interest the Fed pays on reserves since 2008). “Loans create deposits” is of course true in the standard description as well. If banks create money (by lending out, if they want, excess reserves) that necesarily means that the total amount of deposits increases. Because the total amount of deposits (plus the relatively less important amount of physical money in circulation) is what we call money!

by kgwgk 7y ago

JumpCrisscross 7y ago

The loans are created first. At the end of the day, if reserves are inadequate, they are borrowed. This creates the overnight interbank market. Because a dollar dealt results in a deposited, this system is self-reinforcing.

kgwgk 7y ago
But this is not really different from the standard description: you deposit an incremental $1 (cash or a loan) into the banking system and the banking system can loan out $5 (edit: in fact, 0.9$ at first) when it decides to do so. Banks can create this new money “multiplying” deposits (or the central bank intervention is required to create “extra” money).
- JumpCrisscross 7y ago
  > this is not really different from the standard description It is. It’s the difference between picturing a rocket propelled by expanding gases versus a vessel thrust forth by Newtonian dynamics. It is correlation versus causality. Loans cause deposits. Deposits correlate with loans. This discrepancy is the source of money supply estimation error. $1 deposited doesn’t create $5 in loans. $5 in loans prompts about $1 in reserves. The difference in these models explains the interbank market, per se and in terms of rates; reserves as a stochastic versus deterministic phenomenon; bank runs and much more. Loans create deposits. Not the other way. Modern banking makes sense once you internalise this difference.
  - kgwgk 7y ago
    If your point is that the actual money issued by the central bank (M0) does not necessarily result in the monetary supply that could be potentially produced according to the minimal reserve requirements that’s obviously true. Banks are not forced to loan out as much as they could, they have a choice. And because the system is not working at “full capacity” the central bank cannot control the money supply adjusting the minimal reserve requirements. They use other mechanism like short term rates (including through the interest the Fed pays on reserves since 2008). “Loans create deposits” is of course true in the standard description as well. If banks create money (by lending out, if they want, excess reserves) that necesarily means that the total amount of deposits increases. Because the total amount of deposits (plus the relatively less important amount of physical money in circulation) is what we call money!