Good progress here. Paul Sheard, Chief Global Economist at S&P has been reading Godley and Lavoie and gets right to the crux of why QE didn’t cause an explosion in lending or reserve “expansion”:
“John Maynard Keynes famously wrote that: “Practical men, who believe themselves to be quite exempt from any intellectual influence, are usually the slaves of some defunct economist.” (1) A modern example of that dictum, relevant to the economy, policy, and markets, is the widespread view that banks can “lend out” their reserves (deposits) at the central bank, as if bank reserves represented a pool of money that is just waiting to “flow into” bank lending. Because such a thing cannot occur and therefore has not occurred, the point is usually made in reverse: banks currently are not “lending out” their reserves–rather they are “parking” their reserves at the central bank or leaving them “idle.” But that they might lend them out in the future is a lurking risk and a reason to be cautious about the central bank engaging in aggressive quantitative easing (QE) (2).
Many talk as if banks can “lend out” their reserves, raising concerns that massive excess reserves created by
QE could fuel runaway credit creation and inflation in the future. But banks cannot lend their reserves directly to commercial borrowers, so this concern is misplaced.
• Banks do need to hold reserves (as a liquidity buffer) against their deposits, and banks create deposits when they lend. But normally banks are not reserve constrained, so excess reserves do not loosen a reserve
• Banks in aggregate can reduce their reserves only to the extent that they initiate new lending and the bank
deposits created as a result flow into the economy as new banknotes as the public demands more of them.
• QE does aim to ease financial conditions and spur more bank lending than otherwise would have occurred, but the mechanisms by which this happens are much more subtle and indirect than commonly implied.
• If the excess reserves created by QE were to be associated with too much credit creation, central banks could readily extinguish them.”
Old news to anyone who read my 2010 paper on QE….
h/t Josh Brown