When a bank issues a loan it creates a credit in the borrower’s account. When the borrower withdraws/transfers the money from their account the money comes from the bank’s reserves. The bank’s reserves consists of deposits and other liquid assets. The money in the bank’s reserves started its life by being created by the federal government. You may argue that the bank is loaning money that it does not hold in reserves, but for lack of a better description, this is a huge liability for the bank that can create insolvency issues (bank run). For this reason, I do not agree that banks create money when they issue loans, since the bank’s reserves are not created by the bank.
The money in the bank’s reserves started its life by being created by the federal government.
No, you’re misunderstanding how the money supply works. The creation of physical printed money might happen by the government, but those physical dollars represent such a small portion of the overall money supply.
First of all, through fractional reserve banking, one physical dollar can get multiplied many times over to represent many dollars in circulation. Especially because most transactions happen on paper, through a ledger that transfers funds from one account to another.
Everything you’re saying still relates to the practical limits of money creation by commercial banks, in terms of creditworthiness (banks don’t want to lend money they can’t get back) and liquidity/regulation (banks don’t want to be left vulnerable without sufficient reserves to satisfy account holders demanding their deposits).
Realistically, the bank takes one of their own assets, such as the balance on the loan, and uses that as collateral to borrow liquid cash as needed for its own reserves (which are only a fraction of the total deposits in its accounts). And every dollar in a circle in a closed loop that doesn’t touch the Fed is a dollar that doesn’t actually trace back to a governmental entity. The Fed is a lender of last resort, but they’re a last resort because they generally charge higher interest than bank to bank loans.
So of the entire money supply, the vast majority of it is dollars created by banks, not dollars created by the government.
You’re right that that article does talk about banks creating money and it’s true that banks can create money when they lend more than they have in reserves and assets. But my larger point was that IMO bank loans are credit but the bank loans are repaid with actual money. Maybe it’s semantics.
Also, you mentioned fractional reserve banking but that no longer exists. It ended around 2020 when the government changed regulations and no longer requires banks to hold any ratio of reserves to debt.
it’s true that banks can create money when they lend more than they have in reserves and assets
To be clear, the article is saying (and I’m saying) that the bank creates money every time it makes a loan, in the amount of the loan. Regardless of whatever its reserve and asset situation is. An asset and a liability are created in that moment that cancel out, and then each side can take their asset and do something with it: the borrower uses that cash to spend, and the lender uses that loan balance as an asset it can borrow against or otherwise count on income from.
IMO bank loans are credit but the bank loans are repaid with actual money.
It’s repaid with actual money, but it’s all actual money. When the loan is created the balance in the deposit account can be withdrawn or transferred from there and it’s real money that can buy real goods and real services. The money is created, and then it’s real money in the economy. Then the loan is repaid with real money, and then destroyed in the act of repayment and reducing the balance owed on the loan.
Also, you mentioned fractional reserve banking but that no longer exists. It ended around 2020 when the government changed regulations and no longer requires banks to hold any ratio of reserves to debt.
No, that had the opposite effect of what you think. The minimum reserve requirement was abolished, so banks could then do fractional reserve banking in any fraction they pleased, including even smaller ratios than what was previously allowed. The change in regulation didn’t eliminate fractional reserve banking; it eliminated limits on fractional reserve banking, and every bank continued to hold a reserve that is much, much smaller than 100% of the amount of their deposit liabilities. So the fractions still exist. And can continue to exist in any number, with other practical limits on their ability to loan (creditworthiness and solvency).
I didn’t consider that you could still classify banking as fractional reserve banking even though there are no fractional reserve banking requirements. In my mind the concept was one of regulatory oversight.
Do you think that when a bank loans money to another bank they are creating money out of thin air? If they can do that then why do they need to borrow money?
I think you’re doing a good job interpreting and explaining modern monetary theory, I just don’t agree with all of it, although I agree with the concept.
Do you believe that the US government must collect taxes before it can spend money? Or do you agree that government spending is self financed and money creation (in spending by the US government) is only limited by concerns of inflation?
Do you believe that Banks hold digital money in their reserves? I do. Who do you think created that money?
In my mind the concept was one of regulatory oversight.
No, the core concept is one of whether a bank has full reserves, sufficient to cover all of the deposit liability. If the bank keeps only a fraction of the total liability in reserves, then that’s a fractional reserve.
Do you think that when a bank loans money to another bank they are creating money out of thin air?
Yes, that creates money.
If they can do that then why do they need to borrow money?
They need to borrow money for liquidity, to cover the payments they owe to others. An IOU isn’t money, so having a bunch of IOUs in the asset column may require a bank to pledge those IOUs to borrow some money from someone else, maybe even another bank. Then, with money in hand, they can make payments to fund their own operations (pay employees, rent, vendors, taxes, etc.) and pay depositors on demand.
And as a financial institution borrows too much and pays that interest, or is overextended without enough assets to remain solvent/liquid to be able to make payments as they’re due, they may find themselves with insufficient creditworthiness to be able to borrow freely (as other banks are wary of lending to someone who might not pay back). And they might fail. So that general concern always provides a limit on how much they can borrow from other private entities.
They can borrow from the central bank as a lender of last resort, but that carries a cost (and can still only borrow as much as their assets can support). If they’re paying more interest to their creditors than they’re collecting from their borrowers, they’re gonna fail.
Do you believe that the US government must collect taxes before it can spend money? Or do you agree that government spending is self financed and money creation (in spending by the US government) is only limited by concerns of inflation?
No, the government can (and does) borrow money to finance its operations, as well. For the U.S., the sheer amount of government spending is such a high percentage of economic activity that it would be highly inflationary to combine the fiscal power of spending money with the monetary power of controlling the money supply (through creation of base currency, influencing private transactions and interest rates to control bank-created money, and buying/selling securities on the open market).
I think if we lived in a different system without an independent central bank, we’d see a lot of different things going on, including a temptation to elected officials to just create money without regard to inflationary effects. But in the current system, most of the money is created by banks.
Do you believe that Banks hold digital money in their reserves? I do.
Yes, that’s what we’ve been talking about the whole time. When a commercial bank creates a loan, that’s just a ledger that creates an asset in one column and a liability in another column. It could be paper, or it could be digitally stored. If the funds are transferred electronically to another bank, that’s often an electronic record with no physical movement of anything. So yes, those are effectively digital dollars that can be withdrawn as paper money on demand at any given time.
When a bank issues a loan it creates a credit in the borrower’s account. When the borrower withdraws/transfers the money from their account the money comes from the bank’s reserves. The bank’s reserves consists of deposits and other liquid assets. The money in the bank’s reserves started its life by being created by the federal government. You may argue that the bank is loaning money that it does not hold in reserves, but for lack of a better description, this is a huge liability for the bank that can create insolvency issues (bank run). For this reason, I do not agree that banks create money when they issue loans, since the bank’s reserves are not created by the bank.
Your own link from the Bank of England starts off with the thesis that agrees with me:
And you might as well link to the canonical URL of the PDF or the Bank of England website landing page for that article instead of Google Drive acting as a middleman.
No, you’re misunderstanding how the money supply works. The creation of physical printed money might happen by the government, but those physical dollars represent such a small portion of the overall money supply.
First of all, through fractional reserve banking, one physical dollar can get multiplied many times over to represent many dollars in circulation. Especially because most transactions happen on paper, through a ledger that transfers funds from one account to another.
Everything you’re saying still relates to the practical limits of money creation by commercial banks, in terms of creditworthiness (banks don’t want to lend money they can’t get back) and liquidity/regulation (banks don’t want to be left vulnerable without sufficient reserves to satisfy account holders demanding their deposits).
Realistically, the bank takes one of their own assets, such as the balance on the loan, and uses that as collateral to borrow liquid cash as needed for its own reserves (which are only a fraction of the total deposits in its accounts). And every dollar in a circle in a closed loop that doesn’t touch the Fed is a dollar that doesn’t actually trace back to a governmental entity. The Fed is a lender of last resort, but they’re a last resort because they generally charge higher interest than bank to bank loans.
So of the entire money supply, the vast majority of it is dollars created by banks, not dollars created by the government.
You’re right that that article does talk about banks creating money and it’s true that banks can create money when they lend more than they have in reserves and assets. But my larger point was that IMO bank loans are credit but the bank loans are repaid with actual money. Maybe it’s semantics.
Also, you mentioned fractional reserve banking but that no longer exists. It ended around 2020 when the government changed regulations and no longer requires banks to hold any ratio of reserves to debt.
To be clear, the article is saying (and I’m saying) that the bank creates money every time it makes a loan, in the amount of the loan. Regardless of whatever its reserve and asset situation is. An asset and a liability are created in that moment that cancel out, and then each side can take their asset and do something with it: the borrower uses that cash to spend, and the lender uses that loan balance as an asset it can borrow against or otherwise count on income from.
It’s repaid with actual money, but it’s all actual money. When the loan is created the balance in the deposit account can be withdrawn or transferred from there and it’s real money that can buy real goods and real services. The money is created, and then it’s real money in the economy. Then the loan is repaid with real money, and then destroyed in the act of repayment and reducing the balance owed on the loan.
No, that had the opposite effect of what you think. The minimum reserve requirement was abolished, so banks could then do fractional reserve banking in any fraction they pleased, including even smaller ratios than what was previously allowed. The change in regulation didn’t eliminate fractional reserve banking; it eliminated limits on fractional reserve banking, and every bank continued to hold a reserve that is much, much smaller than 100% of the amount of their deposit liabilities. So the fractions still exist. And can continue to exist in any number, with other practical limits on their ability to loan (creditworthiness and solvency).
I didn’t consider that you could still classify banking as fractional reserve banking even though there are no fractional reserve banking requirements. In my mind the concept was one of regulatory oversight.
Do you think that when a bank loans money to another bank they are creating money out of thin air? If they can do that then why do they need to borrow money?
I think you’re doing a good job interpreting and explaining modern monetary theory, I just don’t agree with all of it, although I agree with the concept.
Do you believe that the US government must collect taxes before it can spend money? Or do you agree that government spending is self financed and money creation (in spending by the US government) is only limited by concerns of inflation?
Do you believe that Banks hold digital money in their reserves? I do. Who do you think created that money?
No, the core concept is one of whether a bank has full reserves, sufficient to cover all of the deposit liability. If the bank keeps only a fraction of the total liability in reserves, then that’s a fractional reserve.
Yes, that creates money.
They need to borrow money for liquidity, to cover the payments they owe to others. An IOU isn’t money, so having a bunch of IOUs in the asset column may require a bank to pledge those IOUs to borrow some money from someone else, maybe even another bank. Then, with money in hand, they can make payments to fund their own operations (pay employees, rent, vendors, taxes, etc.) and pay depositors on demand.
And as a financial institution borrows too much and pays that interest, or is overextended without enough assets to remain solvent/liquid to be able to make payments as they’re due, they may find themselves with insufficient creditworthiness to be able to borrow freely (as other banks are wary of lending to someone who might not pay back). And they might fail. So that general concern always provides a limit on how much they can borrow from other private entities.
They can borrow from the central bank as a lender of last resort, but that carries a cost (and can still only borrow as much as their assets can support). If they’re paying more interest to their creditors than they’re collecting from their borrowers, they’re gonna fail.
No, the government can (and does) borrow money to finance its operations, as well. For the U.S., the sheer amount of government spending is such a high percentage of economic activity that it would be highly inflationary to combine the fiscal power of spending money with the monetary power of controlling the money supply (through creation of base currency, influencing private transactions and interest rates to control bank-created money, and buying/selling securities on the open market).
I think if we lived in a different system without an independent central bank, we’d see a lot of different things going on, including a temptation to elected officials to just create money without regard to inflationary effects. But in the current system, most of the money is created by banks.
Yes, that’s what we’ve been talking about the whole time. When a commercial bank creates a loan, that’s just a ledger that creates an asset in one column and a liability in another column. It could be paper, or it could be digitally stored. If the funds are transferred electronically to another bank, that’s often an electronic record with no physical movement of anything. So yes, those are effectively digital dollars that can be withdrawn as paper money on demand at any given time.
Really interesting. I just read the Bank of England’s companion article: Money in the modern economy, an introduction https://www.bankofengland.co.uk/quarterly-bulletin/2014/q1/money-in-the-modern-economy-an-introduction