Hey Joe, Banks Can’t Lend Out Reserves

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I began another post crit­i­cal of Joe Stiglitz’s analy­sis with the caveat that I like Joe. I’ll add to that that I respect his intel­lect too, both because he’s very bright—you don’t win a Nobel Prize (even in Eco­nom­ics!) with­out being very bright—and because com­pared to some other win­ners, he is very capa­ble of think­ing beyond the lim­i­ta­tions of the main­stream.

But there are some main­stream con­cepts that are so deeply embed­ded in even highly intel­li­gent, flex­i­ble thinkers like Joe, that they con­tinue think­ing in terms of them, when a bit of really seri­ous thought would show that the con­cepts are in fact non­sense.

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About Steve Keen

I am Professor of Economics and Head of Economics, History and Politics at Kingston University London, and a long time critic of conventional economic thought. As well as attacking mainstream thought in Debunking Economics, I am also developing an alternative dynamic approach to economic modelling. The key issue I am tackling here is the prospect for a debt-deflation on the back of the enormous private debts accumulated globally, and our very low rate of inflation.
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  • F. Beard

    So why can’t banks do what the vast major­ity of econ­o­mists believe they can and should do—lend the excess reserves that QE has cre­ated to the pub­lic? ” Steve Keen

    It’s really this sim­ple, Steve: Banks can’t lend out their reserves because indi­vid­u­als, busi­nesses, etc. MAY NOT have accounts at the cen­tral bank. Oth­er­wise com­mer­cial banks COULD lend their reserves to the pub­lic, same as they do to each other and to the cen­tral bank itself.

    It’s really that sim­ple and that out­ra­geous too when one con­sid­ers that the pub­lic is FORCED to lend their fiat (aka reserves) to com­mer­cial banks, credit unions, etc. since the mon­e­tary sov­er­eign, eg. US Trea­sury, has NO OTHER CHOICE but to direct its pay­ments to com­mer­cial banks, credit unions, etc. since indi­vid­ual, busi­ness, etc. accounts are not allowed at the cen­tral bank.

    If you’re not out­raged then you do not yet under­stand how the poor are forced to lend their fiat to the com­mer­cial banks, credit unions, etc. but when it comes to “loans” (actu­ally new liability/deposit cre­ation by the com­mer­cial banks, etc) they are the least so-called credit wor­thy.

  • twowith­inthree­thati­sone

    Indi­vid­u­als are not forced to lend their money to banks, but they are forced to bor­row in order to increase their incomes other than work for pay. Con­sid­er­ing that aggre­gate indi­vid­ual income is rapidly being reduced by inno­va­tion and AI, and also that vir­tu­ally every busi­ness cre­ates a greater flow of costs than it dis­trib­utes in indi­vid­ual incomes.…the only way this cost infla­tion­ary and income defla­tion­ary con­di­tion can be resolved is for the cen­tral bank to open its mem­ber­ship to every indi­vid­ual and have a pol­icy man­date to GIFT the indi­vid­ual with a sup­ple­men­tary income.

  • F. Beard

    Of course the poor may with­draw their fiat in the form of phys­i­cal cash (paper bills and coins) but that’s far infe­rior to inher­ently risk-free accounts at the cen­tral bank, which EVERYONE should be allowed to have if equal pro­tec­tion under the law means any­thing.

  • F. Beard

    Indi­vid­u­als are not forced to lend their money to banks” twowith­inthree­thati­sone

    In the case of those who receive pay­ments from the mon­e­tary sov­er­eign (eg. US Social Secu­rity recip­i­ents, US Fed­eral work­ers, the US Mil­i­tary, con­trac­tors to the US Fed­eral gov­ern­ment, etc.) they are indeed forced to lend their fiat, at least tem­porar­ily, to com­mer­cial banks, credit unions, etc. since there is nowhere else* to send the direct deposits. Like­wise with phys­i­cal checks from the mon­e­tary sov­er­eign; they can­not be deposited to indi­vid­ual, busi­ness, etc. accounts at the cen­tral bank since those are not allowed but must be deposited to com­mer­cial banks, credit unions, etc.

    *ie. indi­vid­ual, busi­ness, etc accounts at the cen­tral bank.

  • F. Beard

    … and have a pol­icy man­date to GIFT the indi­vid­ual with a sup­ple­men­tary income. twowith­inthree­thati­sone

    Except that is prop­erly a func­tion of the mon­e­tary sov­er­eign, not the cen­tral bank.

    But yes, new fiat, besides that cre­ated by deficit spend­ing by the mon­e­tary sov­er­eign, should be equally dis­trib­uted to cit­i­zen accounts at the cen­tral bank. From there it can be lent peer-to-peer to the com­mer­cial banks, etc., if desired, or to other peers at the cen­tral bank (indi­vid­u­als, busi­nesses, etc).

  • John­Smith

    @Steve Keen:
    Even if the cen­tral bank were allowed to lend “reserves” by really trans­fer­ing reserves ((like hand­ing over a bar of gold) then the account­ing in “Table 3” and “Table 4” are faulty. Why?
    It is an asset swap, and not a bal­ance sheet exten­sion. So there is no change of the lia­bil­ity side. The reserves were just swapped with the loan. So it looked like:
    Assets: reserves –1$, loans +1$
    Lia­bil­i­ties: no change.
    The sum is still zero as you can see and it makes sense since there is no addi­tional liablity that the cen­tral bank had to serve. 😉
    But since we know that it is for­bid­den to trans­fer reserves this is just the­o­ret­i­cal. Best!

  • John­Smith

    Just saw that the bal­ance sheets were from the com­mer­cial bank and not the cen­tral bank in the tables. Sorry for that! But the account­ing pat­tern would be the same, if hand­ing out real cash or gold.

  • John­Smith

    @multiplier effect and bank lend­ing:
    If a com­mer­cial bank hands out a loan its bal­ance sheet would change like fol­lowed (as Prof. Keen explained):
    Assets: loans +1$
    Lia­bil­i­ties: deposits –1$
    So in this case it is a bal­ance sheet exten­sion and can be done as long as the bal­ance sheet stays in the reg­u­la­tions like Basel II, which has two major con­straints:
    — reserve require­ment of at least 1% of total deposits
    — capital/equity requiremnt of at least 8% (in 2015) of loans
    The sec­ond con­straint usu­ally is more restric­tive than the first in prac­tice.
    If for exam­ple a new opened bank had:
    Assets: reserves +2$ and Lia­bil­i­ties: equity –2$.
    Then by the first rule a bank were able to hand out loans of size 2$(reserve)/1% = 200$, but the sec­ond rule restricts it to 2$(equity)/8% = 25$.
    But still in this sense there could be a mul­ti­plier effect. But the bot­tle­neck is the capital/equity not the reserves of banks. 😉

  • twowith­inthree­thati­sone

    So what are your poli­cies to sta­bi­lize the sys­tem Dr. Keen?

  • twowith­inthree­thati­sone

    I under­stand you have advo­cated a mod­ern debt jubilee which I com­pletely agree with, but isn’t a one off type action like that kind of a sta­tic pol­icy when the sys­tem is ongo­ing and dynamic?

  • rhk

    The first stage is the Cen­tral Bank makes a loan to the Pri­vate Bank—say of $1 mil­lion. That is shown in Table 2, and at this point the account­ing is accu­rate. QE itself is both an asset for the banks, and a lia­bil­ity: they get the reserves from the Cen­tral Bank, and they are liable to return them to the Cen­tral Bank if it asks for them”.

    steve ..have u made a mis­take here..??

    My under­stand­ing was that QE was the FED pur­chas­ing finan­cial assets from the Pri­vate Banks and pay­ing with out­side money ( ie. cre­at­ing reserves in the deposit accts that Banks have with the FED.)

    That Money belongs to the Pri­vate Banks.… they are free to spend it or lend it out.. in the same way we can write a chq against the deposits in our own trans­ac­tional accts.
    ( I’m using sim­ple com­mon sense… I do real­ize that the reserves are out­side money and don’t “phys­i­cally” leave the reserve sys­tem …unless they might be with­drawn as “cash”..?? ).

    Sim­ple com­mon sense would ask… Why on earth would banks swap finan­cial assets for reserves if they could never spend those reserves..??

    The main rea­son that the Banks are not lend­ing much…might be that they are still heal­ing their bal­ance sheets, or there are few “cred­i­ble” borrowers…or they are still “fear­ful”..

    just my view.

  • guima

    Sim­ple com­mon sense would ask… Why on earth would banks swap finan­cial assets for reserves if they could never spend those reserves..??’

    Well swap­ping a junk asset for a solid asset like reserves would be great for bank in dan­ger of going insol­vent. An asset swap will of course not allow a bank to lend more money to the gen­eral pub­lic because it has not increased their equity. If the reserves are given as a gift though, that would be a dif­fer­ent story.

  • Tim Ward

    Bank lend­ing is not reserve con­strained. Bank lend­ing is cap­i­tal con­strained.

    Bank lend­ing is con­strained by writ­ing stan­dards (loan qual­ity).

  • Bhaskara II

    It might be dif­fer­ent for excess reserves.

    I googled, banks-lend-excess-reserves. And hit con­trol-F and typed in lend to search for the word lend.

    7th para­graph of
    https://www.clevelandfed.org/newsroom-and-events/publications/economic-commentary/2015-economic-commentaries/ec-201502-excess-reserves-oceans-of-cash.aspx

    Before Octo­ber 2008, the costs and ben­e­fits of hold­ing reserves were clear. The cost included fore­gone inter­est, and the ben­e­fits included guard­ing against last-minute out­flows that required imme­di­ate cash, much as a depos­i­tor might set aside cash to cover emer­gency expenses, or an investor might hold reserves enabling him to seize an unfore­seen oppor­tu­nity. If a bank did need addi­tional funds, it could obtain reserves through an overnight loan in the fed­eral funds mar­ket, where banks with extra reserves lend to other banks. The dif­fer­ence between what a bank could lend and what it could bor­row rep­re­sented the ben­e­fit of hold­ing a reserve asset ver­sus the oppor­tu­nity cost of lend­ing it out.”

    One can do the same search in the wiki arti­cle.

    https://en.wikipedia.org/wiki/Excess_reserves

  • Bhaskara II

    More on excess reserves.

    Wiki arti­cle above claims reserves and excess reserves are not in dif­fer­ent accounts in the sec­ond para­graph.

    In the United States, bank reserves are held as FRB (Fed­eral Reserve Bank) credit in FRB accounts; they are not sep­a­rated into sep­a­rate “min­i­mum reserves” and “excess reserves” accounts. The total amount of FRB credit held in all FRB accounts, together with all cur­rency and vault cash form the M0 mon­e­tary base.”

    A def­i­n­i­tion of excess reserves.

    http://www.investopedia.com/terms/e/excess_reserves.asp

    http://www.federalreserve.gov/monetarypolicy/reqresbalances.htm

  • Bhaskara II

    Car­toon, Grad­u­ates talk­ing at grad­u­a­tion.

    You{ve got a money mak­ing gig?”

    I run an online cap and gown rental busi­ness.”

    http://www.caglecartoons.com/media/cartoons/89/2011/05/09/92900_600.jpg

  • Bhaskara II
  • Bhaskara II

    It seems clearer to sep­per­ate the excess reserves and reserves con­cepts. But, one might con­sider excess reserves as reserves (in excess).

  • Bhaskara II

    The exam­ples in the wiki arti­cle on dou­ble entry are very con­fus­ing for the new learner. Because the arti­cle puts exam­ples spe­cial books (orig­o­nal books of entry) and sub­sidiary jour­nals in place of the begin­ning con­cept exam­ples of gen­eral jour­nal entries.

    Those books reduce the amount of entries in a man­ual paper and pen­cil sys­tem of account­ing and are very impor­tant later on. But, most of all account­ing text books cover the gen­eral jour­nal first for pegi­gag­i­cal clar­ity. And the other books above are cov­ered later for man­ual effi­ciency and orga­ni­za­tion and sim­plic­ity for casheers, buy­ers, whoes trans­ac­tions are repeta­tive.

    All those books look dif­fer­ent. The gen­eral jour­nal is uni­form and all account­ing entried can be posted there. Thus the jour­nal is cov­ered first in text books. 

    Those books in the wiki arti­cle meet dou­ble entry require­ments by post­ing indi­vid­ual entries or sums to the com­ple­men­try accounts. This is harder to under­stand before learn­ing the more clear gen­eral jour­nal entry method. 

    A com­plete account­ing sys­tem can be imple­mented and taught with a jour­nal and ledger only. 

    Amost any account­ing text bet­ter explains account­ing more sim­ply than this wiki arti­cle.

    So the sec­tion on books of account makes this arti­cle pegi­gog­icly overly com­pli­cated.

  • Tim Ward

    Reserves in the US are based on/ defined by deposits, not loans.

    Loans cre­ate cap­i­tal require­ments.

    The reserves are con­cerned with the lia­bil­ity side of banks bal­ance sheets, not asset side of bal­ance sheets.

  • Bhaskara II

    Here are two decent arti­cles on debit and credit. I com­mented that debit and credit can apply to things in addi­tion to money.

    In account­ing, if credit is what goes out, then why does income come under credit?”
    https://www.quora.com/In-accounting-if-credit-is-what-goes-out-then-why-does-income-come-under-credit

    This def­i­n­i­tion of funds includes things as funds.
    http://www.thefreedictionary.com/funds

    The Lan­guage of Busi­ness!”
    http://abc-solent.com/learn-the-language-of-business/#comment-33761

    Pro­fes­sor Keen´s +s are deb­its and –s are cred­its. Frome the point of view of the accounts that works very well.

  • Bhaskara II

    Thus the + and — entries sum to zero.