Modern Monetary Theory (MMT): How Fiat Money Works

[JohnfrmClevelan]

yes, your money was created. but it was created by the federal reserve, not a commercial bank. All a commercial bank may have done was to loan you some of someone elses money.

The Bank of England says differently:

"This article explains how the majority of money in the modern economy is created by commercial banks making loans."

http://www.bankofengland.co.uk/publ...lletin/2014/qb14q1prereleasemoneycreation.pdf

 

[imagep]

Well, there is. For bank-created money, the deposit is the liability part, and the promissory note is the asset (to the bank) part. And for government-created money (transfers from the government), the deposit (owed to depositor) is the liability part, and the reserve (which never leaves the Fed) is the asset part. And these parts are severable (making the dollars fungible), because the bank can (and does) transfer reserves when a check is written on bank-created money, while the promissory note stays with the bank.

That's the key - bank assets are largely unreachable by the bank. They have reserves, which stay at the Fed; they have promissory notes, which are just I.O.U.s; and they have some equity, which is reachable.

Those fed held assets, the money, is very reachable, it's all electronic and every night those electrons are rearranged however they need to be to reflect the days banking transactions. Each bank has it's accounts marked up AND down.

Where did you hear this?

When a bank issues a check, and that check is deposited into someone else's account at another bank, the fed marks down that banks account, just as they do when any check clears the fed. The bank who gets the deposit has it's account at the fed marked up. The purpose of having reserve accounts at the fed is for the fed to act as a clearing house for transactions, and every transaction involves offseting transactions at the fed, these offseting transactions can be in the same account, or between two different banks accounts.

I didn't "hear that" anywhere, thats simply the way that our banking system works. It's called "centralized banking".

 

[imagep]

The Bank of England says differently:

"This article explains how the majority of money in the modern economy is created by commercial banks making loans."

http://www.bankofengland.co.uk/publ...lletin/2014/qb14q1prereleasemoneycreation.pdf

there is nothing in that article that is contradictory to my statement. the article very clearly explains how the same money is loaned out and redeposited over and over again, creating what it refers to as "broad money" without actually effecting the MB.

"Broad money" is simply the same MB circulating by the process of lending and the deposits of that lending, with no increase in MB. It's the same money being counted over and over again, without the offseting liabilities created by the lending being subtracted out.

And I do believe this may be a semantic issue. the "broad money" discussed in the article is clearly different than the MB, yet a unit of a particular currency is a unit of a particular currency and any true measure of our money supply would count all dollars just the same. The M2+ metrics aren't true measures of our money supply, they are measures of how much money could theoretically be accessed, if it was possible for them to be accessed simultainiously (which it is not). We may call the M2 a measure of our money supply, but it's a measure of something else, not our actual money supply.

It's maybe like the difference between the unemployment rate and the lfpr. They may sound similar, but they are measuring very different things.

 

[JohnfrmClevelan]

Those fed held assets, the money, is very reachable, it's all electronic and every night those electrons are rearranged however they need to be to reflect the days banking transactions. Each bank has it's accounts marked up AND down.

By the Fed, not by the banks. The banks can't touch their reserves on their own. They have to effect a transaction in order to change their reserve balance.

When a bank issues a check, and that check is deposited into someone else's account at another bank, the fed marks down that banks account, just as they do when any check clears the fed. The bank who gets the deposit has it's account at the fed marked up. The purpose of having reserve accounts at the fed is for the fed to act as a clearing house for transactions, and every transaction involves offseting transactions at the fed, these offseting transactions can be in the same account, or between two different banks accounts.

Yes - but checks are always transfers. Loans are different.

I didn't "hear that" anywhere, thats simply the way that our banking system works. It's called "centralized banking".

Well, the part about the Fed debiting a bank's reserve account when they make a loan is incorrect. Loans themselves don't transfer money between banks.

 

[JohnfrmClevelan]

there is nothing in that article that is contradictory to my statement. the article very clearly explains how the same money is loaned out and redeposited over and over again, creating what it refers to as "broad money" without actually effecting the MB.

"Broad money" is simply the same MB circulating by the process of lending and the deposits of that lending, with no increase in MB. It's the same money being counted over and over again, without the offseting liabilities created by the lending being subtracted out.

Their second bullet point:

"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."

That sounds pretty contradictory to what you are saying. Especially when it comes to loans.

 

[imagep]

By the Fed, not by the banks. The banks can't touch their reserves on their own. They have to effect a transaction in order to change their reserve balance.

Sure they can. It happens every time the bank makes a transaction. the fed adjusts their reserve account. Thats what the reserve account is for, it's a settlement account.

Yes - but checks are always transfers. Loans are different.

Loans usually are in the form of a check, or some form of electronic transfer. Heck, a loan could even be made in cash. Are you going to argue not that the bank printed that cash with their own cash printing machine? If a bank makes a loan for a million dollars or for one dollar, and that money is deposited into some other bank, the lending bank most definitely has their reserve account marked down by that much, and the bank who gets the deposit has their account marked up by that much.

Well, the part about the Fed debiting a bank's reserve account when they make a loan is incorrect. Loans themselves don't transfer money between banks.

No it's not.

Last time I got a home mortgage, I sat in an attorney's office, along with the seller, the sellers representative (real estate agent) and the closing attorney. The bank had already given the attorney the check for the loan, $225k. The check required a signature from the loan officer (already on the check) plus my signature. After we signed all the papers, I signed the check and the seller took possession of the check. That check went through the check clearing house at the federal reserve, just like all checks, and the lending banks account was marked down by $225k and the sellers bank's account at the fed was marked up by $225k. I'm pretty darned sure that the lending bank didn't just pick up the phone and tell the fed to credit them with $225k because they were making a loan.

 

[James972]

Believe me, these books will challenge your long-held views on money.
:

if so why so afraid to tell us what our long held views are and what they would be changed to?????????

 

[imagep]

Their second bullet point:

"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."

That sounds pretty contradictory to what you are saying. Especially when it comes to loans.

Not at all to me. Banks are not reserve constrained (reserves are created by deposits), banks can loan and then acquire the funds later, and it is much more complicated than just lending out deposits that savers place with them. that second statement is vague and possibly meaningless.

Our banking system is fairly complex, which is what I am trying to explain. Banks don't just loan from deposits, although the money that banks obtain from deposits certainly can fund loans. Banks don't just magically create money, there is a process that makes it seem like they are creating money, but if any bank just added digits to an account, that would be considered fraud.

 

[James972]

but if any bank just added digits to an account, that would be considered fraud.

who knew????? I guess I won't start a bank then.

 

[imagep]

who knew????? I guess I won't start a bank then.

I realize that sounds absurd, and it is absurd. But some people apparently believe that banks (other than the federal reserve bank) directly issue their own money.

 

[James972]

I realize that sounds absurd, and it is absurd. But some people apparently believe that banks (other than the federal reserve bank) directly issue their own money.

they do in a real sense as long as it is not more than the Fed allows

 

[imagep]

they do in a real sense as long as it is not more than the Fed allows

Can you document the limits that the Fed allows banks to counterfit money up to?

 

[James972]

Can you document the limits that the Fed allows banks to counterfit money up to?

of course:The reserve ratio on net transactions accounts depends on the amount of net transactions accounts at the depository institution. The Garn-St Germain Act of 1982 exempted the first $2 million of reservable liabilities from reserve requirements. This "exemption amount" is adjusted each year according to a formula specified by the act. The amount of net transaction accounts subject to a reserve requirement ratio of 3 percent was set under the Monetary Control Act of 1980 at $25 million. This "low-reserve tranche" is also adjusted each year (see table of low-reserve tranche amounts and exemption amounts since 1982). Net transaction accounts in excess of the low-reserve tranche are currently reservable at 10 percent.

 

[imagep]

of course:The reserve ratio on net transactions accounts depends on the amount of net transactions accounts at the depository institution. The Garn-St Germain Act of 1982 exempted the first $2 million of reservable liabilities from reserve requirements. This "exemption amount" is adjusted each year according to a formula specified by the act. The amount of net transaction accounts subject to a reserve requirement ratio of 3 percent was set under the Monetary Control Act of 1980 at $25 million. This "low-reserve tranche" is also adjusted each year (see table of low-reserve tranche amounts and exemption amounts since 1982). Net transaction accounts in excess of the low-reserve tranche are currently reservable at 10 percent.

Yea, I read the exact same thing. But I thought you were suggesting that banks were allowed to directly create new money. the reserve requirements have nothing to do with the creation of new money.

 

[JohnfrmClevelan]

Not at all to me. Banks are not reserve constrained (reserves are created by deposits), banks can loan and then acquire the funds later, and it is much more complicated than just lending out deposits that savers place with them. that second statement is vague and possibly meaningless.

Our banking system is fairly complex, which is what I am trying to explain. Banks don't just loan from deposits, although the money that banks obtain from deposits certainly can fund loans. Banks don't just magically create money, there is a process that makes it seem like they are creating money, but if any bank just added digits to an account, that would be considered fraud.

I don't want to beat this to death, but are you saying that banks don't create M1 by expanding their balance sheet? You don't agree that they create loans by marking up borrower's account (however temporary) and executing a promissory note? Which really is just adding digits to an account.

They aren't doing anything that grants the bank (or anybody else) a clear asset without a corresponding liability.

 

[csbrown28]

When a bank makes a loan, the banks account at the Fed is reduced by the amount it loans, and when the proceeds of the loan are deposited into a bank, the fed marks up that banks reserve account by that much.

Fundamentally, this is the statement I disagree with. When a bank makes a loan, it marks up the account of the borrower via keystrokes on a PC. The only thing that would need to move around at the end of the day at the Fed is for banks to settle their need for reserves to cover the loans they created, which in theory could be zero. In this way I believe that borrowing increases the money in the money supply, but as an accounting identity all of the money created has date in which it must be retired. In this way, it all balances to zero (not including the interest).

 

[imagep]

Fundamentally, this is the statement I disagree with. When a bank makes a loan, it marks up the account of the borrower via keystrokes on a PC. The only thing that would need to move around at the end of the day at the Fed is for banks to settle their need for reserves to cover the loans they created, which in theory could be zero. In this way I believe that borrowing increases the money in the money supply, but as an accounting identity all of the money created has date in which it must be retired. In this way, it all balances to zero (not including the interest).

Banks have always given me a check or sent a check or electronic transaction to the vendor I was purchasing something from, every time I've borrowed money. that check clears through the federal reserve, which then marks down the issuing bank's account and marks up the account of the bank in which it was deposited.

Even when I use a credit card, there is no money deposited in my account - it goes into the account of the entity I made the purchase from. That entities bank then has more money and the federal reserve marks up their account and marks down the account of the bank that issued the credit card.

 

[imagep]

I don't want to beat this to death, but are you saying that banks don't create M1 by expanding their balance sheet?

It doesn't increase MB. M1 and above count checking accounts (I believe I may have mistakenly said M2 earlier).

You don't agree that they create loans by marking up borrower's account (however temporary) and executing a promissory note? Which really is just adding digits to an account.

I agree that they issue a credit to the borrower or to the borrowers vendor, it may be a direct deposit, but most of the time it is going to be a check or a deposit into another bank. Yes, marking up is done, but marking down is also done. The two marks offset each other, thus there is no new money created.


They aren't doing anything that grants the bank (or anybody else) a clear asset without a corresponding liability.[/QUOTE]

 

[imagep]

Sorry, I realize that my answer wasn't entirely what I had intended, I started editing it and was called away from my desk to do some work and my edit timed out. Here is what I had intended...

I don't want to beat this to death, but are you saying that banks don't create M1 by expanding their balance sheet?

It doesn't increase MB. M1 and above count checking accounts (I believe I may have mistakenly said M2 earlier).

You don't agree that they create loans by marking up borrower's account (however temporary) and executing a promissory note? Which really is just adding digits to an account.

I agree that they issue a credit to the borrower or to the borrowers vendor, it may be a direct deposit, but most of the time it is going to be a check or a deposit into another bank. Yes, marking up is done, but marking down is also done. The lending banks account at the fed is marked down, the bank who receives the deposit has it's account at the fed marked up.


The mark up is the same amount as the mark down, thus there are no more or less reserves once both ends of the transaction is complete. I suppose thats part of the reason I dont think that lending creates new money. It's the same money (physical or electronic) just being shuffled around.

They aren't doing anything that grants the bank (or anybody else) a clear asset without a corresponding liability.

\


The bank has an asset of the note and correspondingly less money in it's account at the fed. the bank that the loan is deposited into has more money in its account at the fed, and a corresponding liability of the deposit. Everything balances after all aspects of the transaction is complete. In otherwords - the money comes from somewhere, it is not created by banks (although it has a similar effect of creating money and seems like it is new money).

 

[JohnfrmClevelan]

Sorry, I realize that my answer wasn't entirely what I had intended, I started editing it and was called away from my desk to do some work and my edit timed out. Here is what I had intended...





It doesn't increase MB. M1 and above count checking accounts (I believe I may have mistakenly said M2 earlier).










I agree that they issue a credit to the borrower or to the borrowers vendor, it may be a direct deposit, but most of the time it is going to be a check or a deposit into another bank. Yes, marking up is done, but marking down is also done. The lending banks account at the fed is marked down, the bank who receives the deposit has it's account at the fed marked up.


The mark up is the same amount as the mark down, thus there are no more or less reserves once both ends of the transaction is complete. I suppose thats part of the reason I dont think that lending creates new money. It's the same money (physical or electronic) just being shuffled around.


\


The bank has an asset of the note and correspondingly less money in it's account at the fed. the bank that the loan is deposited into has more money in its account at the fed, and a corresponding liability of the deposit. Everything balances after all aspects of the transaction is complete. In otherwords - the money comes from somewhere, it is not created by banks (although it has a similar effect of creating money and seems like it is new money).

OK, I think we're on the same page. You are skipping the part where the borrower gets a deposit of his own, which is fine. You aren't counting M1 as "money," just MB, which is fine (although I count M1 as money). Just a different way of looking at the same thing.

 

[imagep]

I've always wondered exactly why MMters sometimes call MB "high powered money", I'm beginning to realize that maybe it's because MB is what all other money is create from.

Sort of like a seed that lending created all money grows from.

Or maybe the foundation of a skyscraper - remove the foundation and the building collapses.

 

[JohnfrmClevelan]

I've always wondered exactly why MMters sometimes call MB "high powered money", I'm beginning to realize that maybe it's because MB is what all other money is create from.

Sort of like a seed that lending created all money grows from.

Or maybe the foundation of a skyscraper - remove the foundation and the building collapses.

I'm not sure myself. I don't see it as necessary, though. Bank money is what we use the most. MB is outside money.

 

[austrianecon]

I've always wondered exactly why MMters sometimes call MB "high powered money", I'm beginning to realize that maybe it's because MB is what all other money is create from.

Sort of like a seed that lending created all money grows from.

Or maybe the foundation of a skyscraper - remove the foundation and the building collapses.

It's not only MMT that calls MB "highpowered" money, most theories do because "its increase will typically result in a much larger increase in the supply of demand deposits through banks' loan-making".. basically Money multiplier ratio.

 

[imagep]

I'm not sure myself. I don't see it as necessary, though. Bank money is what we use the most. MB is outside money.

From your viewpoint, based upon your understanding of how banks create money, then yes.

But my understanding of how banks create money requires that some MB exist, else the bank couldn't create any money.

I think this is probably the most important policy implication between our two different understandings of how banks create money.

If we had a banking system with no money at all (like a new country that has established a currency but hasn't issued any of that currency) then:

1) Under your understanding, banks would just mark up the account of a borrower in exchange for a note. And thus there would be no issue.

2) Under my understanding, the bank wouldn't be able to make any loans, because the bank would have no way to acquire the money overnight, not even if the depositor deposited the loan funds back into a bank account instantly (because the bank still wouldn't have enough to cover the loan and the reserve requirement for the deposit)

So even though we agree that banks can create money, and our only real disagreement is the exact procedure that banks go through to create new money, there can be huge differences in the economic implications.

 

[JohnfrmClevelan]

From your viewpoint, based upon your understanding of how banks create money, then yes.

But my understanding of how banks create money requires that some MB exist, else the bank couldn't create any money.

I think this is probably the most important policy implication between our two different understandings of how banks create money.

If we had a banking system with no money at all (like a new country that has established a currency but hasn't issued any of that currency) then:

1) Under your understanding, banks would just mark up the account of a borrower in exchange for a note. And thus there would be no issue.

2) Under my understanding, the bank wouldn't be able to make any loans, because the bank would have no way to acquire the money overnight, not even if the depositor deposited the loan funds back into a bank account instantly (because the bank still wouldn't have enough to cover the loan and the reserve requirement for the deposit)

So even though we agree that banks can create money, and our only real disagreement is the exact procedure that banks go through to create new money, there can be huge differences in the economic implications.

The difference is that in your case, the government has stepped in and declared, "Legally, banks must follow this regulation." But the thing that banks must do is just a regulation, and is not operationally necessary. Just like bond issuance does not operationally enable a government to issue currency, reserves do not operationally enable a bank to create loans.

If that regulation is in place, then banks would "need" to obtain reserves, and reserves would need to be available. This is the same reasoning we use when we say that the government must spend money into the economy before they can tax it away - it's only because of the system that is in place, where when you write a check to the government, they get "paid" in pre-existing reserves. But before the Fed existed, the government accepted bank-created money, and they used it just like we all use dollars.