Commentaries (some of them cheeky or provocative) on economic topics by Ralph Musgrave. This site is dedicated to Abba Lerner. I disagree with several claims made by Lerner, and made by his intellectual descendants, that is advocates of Modern Monetary Theory (MMT). But I regard MMT on balance as being a breath of fresh air for economics.
Monday, 6 July 2020
Banks intermediate between lenders and borrowers.
It has become fashionable recently to claim that commercial banks do not intermediate between lenders and borrowers, but rather that banks create the money they lend out from thin air. Actually banks do both: i.e. they certainly create money, but once that money is created, it then circulates between one person and another, one firm and another and between one bank and another and indeed between lenders and borrowers.
Moreover, and ironically, a paper that the above mentioned dedicated followers of fashion often quote, namely a Bank of England paper entitled “Money Creation in the Modern Economy” actually supports the above “create AND intermediate” point. At least the second sentence of the paper reads “…..banks do not act simply as intermediaries…”. I.e. the authors are saying banks DO ACT as intermediaries, but that’s not all they do. Quite right.
One way of demonstrating the way in which banks act as intermediaries is as follows.
Suppose a bank finds its deposits have risen by £X million over the last six months, plus suppose the bank thinks those deposits look like being a PERMANENT addition to the bank’s deposits. What’s the bank going to do?
Well it’s pretty much forced to lend out an extra £X million or thereabouts, because if the bank wants to expand it’s market share, or at least maintain its market share, it must pay interest to those new depositors, especially if a significant proportion of those deposits are in term accounts. And where will it get the money to pay that interest? From lending out around an extra £X million or thereabouts!
Ergo . . . roll of drums . . . . banks in effect lend on depositors’ money.
No, if a bank with extra deposits makes new loans, those new loans will also add extra deposits.
ReplyDeleteIf a bank has extra deposits, that means that there are other banks that are short of deposits. The bank ends up swapping deposits for loans or other securities with those other banks.
Interesting point. I agree that if a “bank has extra deposits, that means that there are other banks that are short of deposits.” Or more crucially, those other banks will tend to be short of reserves, which, as you seem to suggest, means those other banks may well sell securities to the “deposit rich” bank. But that means that in effect the deposit rich bank is lending to whoever issued those securities. At least it will certainly in effect be lending where those securities are bonds rather than shares. And that supports my point that a deposit rich bank will lend more by one means or another.
DeleteAt least the above scenario would playout where the bank industry as a whole can’t see a profitable way of making more loans in the aggregate. An alternative scenario is where the bank industry CAN SEE a way of making more loans. But in that scenario, the “reserve poor” banks will be reluctant to lend because to do would tend to mean they’d run short of reserves. Thus it will be the “deposit / reserve rich” bank which will tend to do the lending, which again, supports my basic point.