4 ms·

" For example, right now, central bank could loan lots of money to retail banks, but there's no guarantee that those retail banks will in turn loan it to averag

" For example, right now, central bank could loan lots of money to retail banks, but there's no guarantee that those retail banks will in turn loan it to average consumer." That's because banks don't work like that. Money isn't a thing, it is a unit of account. Banks create money out of nothing by discounting collateral [0]. You turn up with a property, the bank has it valued at $100K. The bank then creates a financial instrument called a 'mortgage' which it holds as an asset on its balance sheet and which is a 'charge' over that property preventing you selling it until you discharge the mortgage. Then they issue $90K of their own liabilities which you call a 'bank deposit' into an account with your name on it. That liability balances the new asset. And that's about it. Loans create deposits. The central bank doesn't get involved in lending at all. Never has. [0]: https://www.bankofengland.co.uk/-/media/boe/files/quarterly-bulletin/2014/money-creation-in-the-modern-economy.pdf https://www.bankofengland.co.uk/-/media/boe/files/quarterly-...

kqr 5y ago
To clarity further: The reserve requirement (banks must maintain so-and-so many percent of their money in central-bank issued reserves) simply means that if, after loans are made, the central bank discovers that the private banking system is low on reserves, the central bank sells new reserves to the banking system to satisfy their demand. In other words, customer demand (which is relatively inflexible: you don't take out loans for fun, you do it because you need them) drives private bank loans, which drives creation of reserves by the central bank. Not the other way around. The market dictates how much money is in circulation, by demanding a particular amount of money. The central bank can't do anything other than oblige, because if demand outpaces supply, our economy will stall.
- danuker 5y ago
  > which drives creation of reserves by the central bank. Not the other way around. How is it that the Federal Reserve added more than $4 Trillion of M2 currency since the pandemic started? [1] Was it responding to the "increased" credit demand from shut down businesses that see no light at the end of the lockdown tunnel? [1] https://fred.stlouisfed.org/series/M2SL https://fred.stlouisfed.org/series/M2SL
  - RobertoG 5y ago
    1. The Federal Reserve have to add reserves to the system when there is demand from the economy in order to keep the interest rate that they want. Otherwise, the interest rate would go up because the offer and demand dynamics between the private banks. 2. If there is not demand from the economy for credit, adding reserves to the system will push the interest rate very low (that's happening now). If there is not demand from the economy those reserves will not be lend, ergo, they will not be inflationary (they could affect other financial assets prizes though). 3. Apart from keeping the interest rate where they want, adding reserves to the system will happen when the fed buy assets from the banks (they are payed with reserves). One of those assets are government bonds. So, the Central Banks can finance without limit (other than inflation) fiscal expansion from the treasury. This money, used to finance government spending, will be spend in the economy. So, it's the fiscal policy what will be inflationary, not the number of reserves per se.
    - lottin 5y ago
      To clarify, you're talking about nominal interest rates. Central banks have little or no control over real interest rates.
      - RobertoG 5y ago
        The difference between nominal and real interest rate is inflation and the main mandate of Central Banks is the control of inflation. So, I don't think it's accurate to say they have no control.
        lottin 5y ago
        Central banks control inflation by setting nominal rates. These two rates are not independent. Setting real interest rates would require the ability to control both nominal rates and the inflation rate independently from one another.
        RobertoG 5y ago
- RobertoG 5y ago
  To clarify a little further, the central banks have some kind of control through the interest rate. The interest rate, at the end, it's not decided by bond markets or private banks lending one to another, but by the central bank adding or removing reserves to the system. So, the central bank can decide to make lending more cheaper (as is the case now) or more expensive (like in the 70's in the USA).
  - kqr 5y ago
    That's the idea, but if I remember correctly there's not a whole lot of evidence suggesting that more borrowing happens when the rate is low, for the reason mentioned above: you don't borrow money for fun when it seems cheap, you borrow money because you need it. Borrowing isn't particularly price sensitive. (It is in the margin in the sense that more doubtful gambles pay off when borrowing is cheaper, but the large part of borrowing happens because of an immediate liquidity demand, not a desire for leverage.)
    - RobertoG 5y ago
      I think that's what they call "pushing on a string" (1). Central banks can make lending/borrowing a worst business (higher interest rate) but they can't force people to borrow. So, monetary policy is very limited when demand falls, then fiscal policy is necessary, but, until recently, fiscal policy was anathema because of ideological reasons. (1) - https://www.investopedia.com/terms/p/push_on_a_string.asp https://www.investopedia.com/terms/p/push_on_a_string.asp

kqr 5y ago

To clarity further: The reserve requirement (banks must maintain so-and-so many percent of their money in central-bank issued reserves) simply means that if, after loans are made, the central bank discovers that the private banking system is low on reserves, the central bank sells new reserves to the banking system to satisfy their demand. In other words, customer demand (which is relatively inflexible: you don't take out loans for fun, you do it because you need them) drives private bank loans, which drives creation of reserves by the central bank. Not the other way around. The market dictates how much money is in circulation, by demanding a particular amount of money. The central bank can't do anything other than oblige, because if demand outpaces supply, our economy will stall.

danuker 5y ago
> which drives creation of reserves by the central bank. Not the other way around. How is it that the Federal Reserve added more than $4 Trillion of M2 currency since the pandemic started? [1] Was it responding to the "increased" credit demand from shut down businesses that see no light at the end of the lockdown tunnel? [1] https://fred.stlouisfed.org/series/M2SL https://fred.stlouisfed.org/series/M2SL
- RobertoG 5y ago
  1. The Federal Reserve have to add reserves to the system when there is demand from the economy in order to keep the interest rate that they want. Otherwise, the interest rate would go up because the offer and demand dynamics between the private banks. 2. If there is not demand from the economy for credit, adding reserves to the system will push the interest rate very low (that's happening now). If there is not demand from the economy those reserves will not be lend, ergo, they will not be inflationary (they could affect other financial assets prizes though). 3. Apart from keeping the interest rate where they want, adding reserves to the system will happen when the fed buy assets from the banks (they are payed with reserves). One of those assets are government bonds. So, the Central Banks can finance without limit (other than inflation) fiscal expansion from the treasury. This money, used to finance government spending, will be spend in the economy. So, it's the fiscal policy what will be inflationary, not the number of reserves per se.
  - lottin 5y ago
    To clarify, you're talking about nominal interest rates. Central banks have little or no control over real interest rates.
    - RobertoG 5y ago
      The difference between nominal and real interest rate is inflation and the main mandate of Central Banks is the control of inflation. So, I don't think it's accurate to say they have no control.
      - lottin 5y ago
        Central banks control inflation by setting nominal rates. These two rates are not independent. Setting real interest rates would require the ability to control both nominal rates and the inflation rate independently from one another.
        RobertoG 5y ago
RobertoG 5y ago
To clarify a little further, the central banks have some kind of control through the interest rate. The interest rate, at the end, it's not decided by bond markets or private banks lending one to another, but by the central bank adding or removing reserves to the system. So, the central bank can decide to make lending more cheaper (as is the case now) or more expensive (like in the 70's in the USA).
- kqr 5y ago
  That's the idea, but if I remember correctly there's not a whole lot of evidence suggesting that more borrowing happens when the rate is low, for the reason mentioned above: you don't borrow money for fun when it seems cheap, you borrow money because you need it. Borrowing isn't particularly price sensitive. (It is in the margin in the sense that more doubtful gambles pay off when borrowing is cheaper, but the large part of borrowing happens because of an immediate liquidity demand, not a desire for leverage.)
  - RobertoG 5y ago
    I think that's what they call "pushing on a string" (1). Central banks can make lending/borrowing a worst business (higher interest rate) but they can't force people to borrow. So, monetary policy is very limited when demand falls, then fiscal policy is necessary, but, until recently, fiscal policy was anathema because of ideological reasons. (1) - https://www.investopedia.com/terms/p/push_on_a_string.asp https://www.investopedia.com/terms/p/push_on_a_string.asp