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So it states: "This description of the relationship between monetary policy and money differs from the description in many introductory textbooks, where centra

So it states: "This description of the relationship between monetary policy and money differs from the description in many introductory textbooks, where central banks determine the quantity of broad money via a ‘money multiplier’ by actively varying the quantity of reserves.(3) In that view, central banks implement monetary policy by choosing the quantity of reserves. And, because there is assumed to be a stable ratio of broad money to base money, these reserves are then ‘multiplied up’ to a much greater change in bank deposits as banks increase lending and deposits. Neither step in that story represents an accurate description of the relationship between money and monetary policy in the modern economy. Central banks do not typically choose a quantity of reserves to bring about the desired short-term interest rate.(4) Rather, they focus on prices — setting interest rates.(5)" Does that mean the whole "Fractional Reserve Banking" explanation is not how it works?

spiralx 4y ago
FRB isn't how banking has ever worked, even when we used commodity money, but it's a relatively simple concept that matches peoples' intuitive sense of money as a fixed amount of tokens used to store wealth. But money's purpose is to facilitate transactions and be a unit of account which should be thought of through the lens of double-entry accounting, something almost nobody does. Banks would always have tracked accounts via ledgers though, it's just that before fiat currencies they had reserve requirements in place to ensure banks kept enough currency on hand to handle day to day withdrawals.
- gilbetron 4y ago
  So is an explanation like this just incorrect? Or an oversimplification? https://www.investopedia.com/terms/f/fractionalreservebanking.asp https://www.investopedia.com/terms/f/fractionalreservebankin... Genuinely curious!
  - skybrian 4y ago
    It's still true that reserves are only a small fraction of deposits, so the part about calling it fractional reserve banking isn't incorrect. But the Bank of England explanation is a lot better.
  - spiralx 4y ago
    From the article you linked: > This is not how money is actually created but only a way to represent the possible impact of the fractional reserve system on the money supply. As such, while is useful for economics professors, it is generally regarded as an oversimplification by policymakers. And from the Bank of England's (very good) primer on money creation: > Money creation in practice differs from some popular misconceptions — banks do not act simply as intermediaries, lending out deposits that savers place with them, and nor do they ‘multiply up’ central bank money to create new loans and deposits. > ... > Rather than banks receiving deposits when households save and then lending them out, bank lending creates deposits The "money multiplier" concept of FRB is a useful model in the same sense that modelling an atom as if it were like a solar system with a solid nucleus with electrons whizzing around it like planets i.e. not really 'true' but a useful-enough approximation for many use cases. The BoE primer explains all of this very clearly on the first couple of pages, it's well worth reading: 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-...
lottin 4y ago
I think what they're trying to say is that although in economic theory central banks are thought to control the quantity of money, in reality they control the price of money. (They can't control both the quantity and the price.) My understanding is that whether they set the price or the quantity of money via monetary policy is a sort of implementation detail that shouldn't make any difference, although I'm by no means an expert.
DalekBaldwin 4y ago
The reserve ratio is one limiting factor among several that affect to what extent commercial banks can expand the money supply. For many decades leading up to the 2008 financial crisis, banks (in the US at least) extended loans up to this limit basically at all times, holding almost no excess reserves. Since then, they have not, and recently the Fed removed the reserve ratio requirement altogether: https://fred.stlouisfed.org/series/EXCSRESNW https://fred.stlouisfed.org/series/EXCSRESNW

spiralx 4y ago

FRB isn't how banking has ever worked, even when we used commodity money, but it's a relatively simple concept that matches peoples' intuitive sense of money as a fixed amount of tokens used to store wealth. But money's purpose is to facilitate transactions and be a unit of account which should be thought of through the lens of double-entry accounting, something almost nobody does. Banks would always have tracked accounts via ledgers though, it's just that before fiat currencies they had reserve requirements in place to ensure banks kept enough currency on hand to handle day to day withdrawals.

gilbetron 4y ago
So is an explanation like this just incorrect? Or an oversimplification? https://www.investopedia.com/terms/f/fractionalreservebanking.asp https://www.investopedia.com/terms/f/fractionalreservebankin... Genuinely curious!
- skybrian 4y ago
  It's still true that reserves are only a small fraction of deposits, so the part about calling it fractional reserve banking isn't incorrect. But the Bank of England explanation is a lot better.
- spiralx 4y ago
  From the article you linked: > This is not how money is actually created but only a way to represent the possible impact of the fractional reserve system on the money supply. As such, while is useful for economics professors, it is generally regarded as an oversimplification by policymakers. And from the Bank of England's (very good) primer on money creation: > Money creation in practice differs from some popular misconceptions — banks do not act simply as intermediaries, lending out deposits that savers place with them, and nor do they ‘multiply up’ central bank money to create new loans and deposits. > ... > Rather than banks receiving deposits when households save and then lending them out, bank lending creates deposits The "money multiplier" concept of FRB is a useful model in the same sense that modelling an atom as if it were like a solar system with a solid nucleus with electrons whizzing around it like planets i.e. not really 'true' but a useful-enough approximation for many use cases. The BoE primer explains all of this very clearly on the first couple of pages, it's well worth reading: 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-...

lottin 4y ago

I think what they're trying to say is that although in economic theory central banks are thought to control the quantity of money, in reality they control the price of money. (They can't control both the quantity and the price.) My understanding is that whether they set the price or the quantity of money via monetary policy is a sort of implementation detail that shouldn't make any difference, although I'm by no means an expert.

DalekBaldwin 4y ago

The reserve ratio is one limiting factor among several that affect to what extent commercial banks can expand the money supply. For many decades leading up to the 2008 financial crisis, banks (in the US at least) extended loans up to this limit basically at all times, holding almost no excess reserves. Since then, they have not, and recently the Fed removed the reserve ratio requirement altogether: https://fred.stlouisfed.org/series/EXCSRESNW https://fred.stlouisfed.org/series/EXCSRESNW