Tuesday, 18 November 2014

Daniel Aronoff versus Positive Money.

It’s game set and match to PM, if you want to know the final score. But details are as follows.

Fran Boait of PM in the letters section of the Financial Times cited a Bank of England publication which pointed out that commercial banks create deposits when they lend.

Daniel Aronoff responded (his 2nd paragraph) by saying that when the DO LEND, that changes the ratio of deposits to bank reserves (which is obviously true, given more or less constant bank reserves).

But he then jumps to the conclusion that that shows that the cause effect relationship can run the other way, i.e. that expanding reserves enables banks to lend more. Unfortunately it is widely accepted by economists that there is only one significant determinant of bank loans: the availability of credit worthy borrowers. I.e. reserves are well nigh irrelevant.

Certainly a large increase or decrease in reserves from their present level is irrelevant so far as bank loans go. In contrast, given the sort of level of reserves that existed prior to the crisis (i.e. about one tenth their present level), banks are then near the minimum stock of reserves that they need for settling up with each other, so the volume of reserves might be argued to be relevant there.

However, even that argument has been widely criticised. Just one example: as Bill Mitchell puts it, “As we have discussed many times banks seek to attract credit-worthy customers to which they can loan funds to and thereby make profit…..These loans are made independent of the banks’ reserve positions.”

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