Regular readers will be more than familiar with the debunking of the money multiplier and the concept that banks don’t lend out reserves or deposits (see here & here), but it’s nice to see it catching on in places more important than this lowly blog. A new research report out of the Bank of England debunks the money multplier in one of the best overall presentations of the concept that I’ve seen. And much of it sounds like stuff I could have written (in fact, I’ve stated almost all of these points at times during the last 5 years). I won’t go into too much detail, but here are a few highlights:
• the majority of money in the modern economy is created by commercial banks making loans.
• 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.
• The amount of money created in the economy ultimately depends on the monetary policy of the central bank. In normal times, this is carried out by setting interest rates. The central bank can also affect the amount of money directly through purchasing assets or ‘quantitative easing’.
They also do a good bit of explaining on QE and its operations. I personally think they overstate the case with regards to how the central bank “ultimately” determines the amount of money created, but I think they’re trying to emphasize the fact that the Central Bank is the regulator and price setter of reserves. But don’t mistake this for the BOE implying that the Central Bank controls loan creation directly. I might have said it a bit differently, but their point is totally consistent with Monetary Realism’s views.
You can read the full report here. I highly recommend it.
Some related work:
- Understanding the Modern Monetary System
- Your Textbooks Lied to you – the Money Multiplier is a Myth
- Understanding Quantitative Easing
- Economics and Banking – James Tobin 1963 (Redux), by JKH
- Krugman and Tobin on Banking, by JKH