Tuesday, 17 July 2012

What proportion of the money supply is created by private banks?

Positive Money and the New Economics Foundation say about 97%, and on the grounds that about 3% of money consists of physical cash (£20 notes, etc). Therefor the rest must be privately created.

Frances Coppola says the figure is significantly less than 97% because the above reasoning leaves out commercial bank reserves at the central bank – an argument I’ve been putting for some time. But that's not the end of the argument.

Central bank money or “monetary base” comes into existence when government makes any sort of payment (e.g. a tax rebate or social security payment). Each recipient of those payments will deposit most of the money in a commercial bank. And the commercial bank will have its account at the central bank credited.

Assuming government pays out more than it receives during some period, that means the initial effect is to boost private banks’ stock of reserves by some given amount. And the latter amount of money has clearly been created by government – or if you like, the central bank.

Thus it seems reasonable to say that reserves are central bank created money. Moreover, such money is in effect in circulation: that is the above non-bank recipients (recipients of tax rebates or social security payments) can do what they want with the money. But that does not mean we can get at the total amount of money in circulation that is central bank created by adding up physical cash and bank reserves.

Reason is that as soon as private banks think they have more reserves than they need, they use the surplus to invest in something with a better yield (reserves normally pay no interest).

Thus to get at the proportion of money created by central bank it strikes me we need take physical cash add total deposits and subtract total loans.

This site gives the deposit to loan ratio of U.S. FDIC insured banks as 79%. (loans are $7.28 trillion while total deposits are $9.22 trillion).

From that I deduce that about 20% of money in the U.S. is central bank created. But I’m bound to have gone wrong somewhere.

Any ideas?



  1. The main issue is that there is a currency peg between the central bank and the private bank.

    So when the central bank transfers money to a private bank, the private bank is forced to create some more of its own liabilities to maintain the currency peg.

    Actual cash is the only central bank liability that can be held by individuals.

    Everything else is a private bank liability.

    Probably the real way to work it out is to consider what people would be left with if all the private banks went bust.

    So they'd get to keep their cash, and they'd get their insured deposits paid out and they'd get to hold onto their government bonds.

    Everything else is private money.

    1. “Probably the real way to work it out is to consider what people would be left with if all the private banks went bust.” I think I kind of agree with that: it produces the same answer as I got above.

      If all loans made by private banks turned out to be totally worthless, they’d be left with the reserves they had at the central bank plus whatever reserves they had previously turned into government debt. The total of those two as I see it will be equal to the total of central bank created money.

  2. This is an important subject in the current debate. Given that loans create deposits (as the method of bank lending), your logic makes sense to me. The New Arthurian Economics has had some good work related to this matter which I think suggests a similar figure.


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