Money and banking

Posted: 27 October 2014 in Uncategorized
Tags: , , , , , , ,


It’s a good thing I don’t teach Money and Banking. I wouldn’t be very good at it. That’s because, as Magpie and Bruce remind me, my understanding of money and banking is riddled with myths and bad textbook theories.

But I am willing to learn. . .


Lesson #1: it is not the case, as countless textbooks and on-line courses teach, that banks collect the deposits of countless small savers and loan them out for investment projects. That image—of banks as useful financial intermediaries, given the existence of money—is simply false. Instead, what banks (commercial banks, that is) do is make interest-earning loans and leases and then, on the opposite side of the ledger, credit deposits—thus creating money.

So, what role do customer deposits play if not to create loans? According to Ellen Brown, “while banks do not need the deposits to create loans, they do need to balance their books; and attracting customer deposits is usually the cheapest way to do it.”


Lesson #2: quantitative easing has not involved the Fed printing money, and then giving that money (as costless or free cash) to banks in order to encourage lending (much less to buy back government debt). Instead, what the Fed has done is expand bank reserve deposits by purchasing Treasury bonds (and mortgage-backed securities) from banks, thereby increasing both the Fed’s holding of Treasury securities and the excess reserves of depository institutions.

The fact is, however, banks of late have renewed their purchases of government debt instruments (as we can see in line 3 of the latest Assets and Liabilities of Commercial Banks in the United States statement). The question is, why? According to Bloomberg, commercial lenders have increased their holdings of Treasury bonds this year “as loan growth fails to keep up with record deposits and banks prepare for rules that take effect in January requiring them to hold more high-quality assets.”

As I see it, banks are not lending at the pace we (and, for that matter, the Fed) would like not because they don’t have adequate reserves (as Paul Krugman argues today) but because they don’t see enough profitable opportunities among their corporate customers—who are not investing but, instead, hoarding their cash, buying back stock, and finding ways to shelter their income from taxes.

The fact is, the nature and pace of the current recovery are not determined by the savings of individuals and households, but of the profit-seeking investment decisions of large private banks and corporations.

So, thanks to Magpie and Bruce, I’ve learned a few things. But, I’ll admit, I still may be getting some of this wrong—and therefore am still not ready to teach Money and Banking.

  1. Magpie says:

    Prof. Ruccio,

    I’m just an amateur (a beginning and not very gifted one, at that, I’m afraid).

    But this paper created a bit of an stir a few months ago (Ellen Brown linked to it, too): “Money creation in the modern economy”, by Michael McLeay, Amar Radia and Ryland Thomas of the Bank of England’s Monetary Analysis Directorate (BoE Quarterly Bulletin 2014 Q1).

    Is my understanding that it gives a good overview (it’s easily found with Google and it seems more than one link causes a comment to receive a spam flag), and, for what it is worth, I found it pretty good.

    Prof. Bill Mitchell (a leading MMTer) has commented on this paper and has some easy-to-follow observations (including a ten-step process, near the end of the post):

    Macroeconomic textbooks ripe for composting
    Posted on Thursday, July 17, 2014

    If one thinks about it, step 8:

    “The banks will as a consequence of the higher deposits “want, or are ** REQUIRED **, to hold more central bank money in order to meet withdrawals by the public or make payments to other banks”. That is, the bank will need to increase its ‘reserves’ held at the central bank to facilitate the payments system”

    Is the reason why reserves are kept: legal reserve requirements or whatever additional prudential constrains the bank imposes on itself.

    Note also that Prof. Mitchell (following the BoE paper) distinguishes between “reserves” and “EXCESS reserves”:

    “Why do economists claim that banks lend out their reserves. The only clue that the Bank of England provides is that ‘Part of the confusion may stem from economists’ use of the term ‘reserves’ when referring to ‘excess reserves’ – balances held ** ABOVE ** those required by regulatory reserve requirements.
    “Accordingly, they claim that ‘lending out reserves’ ‘could be a shorthand way of describing the process of increasing lending and deposits until the bank reaches its maximum ratio’.”

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