Hey Steve, Banks Can Lend At Will…Almost, Don’t They?

@ProfSteveKeen is among those few economists who correctly called the Financial Crisis of 2008, and who now predicts that another one is about to burst where conventional “medicines” like QE, ZIRP or NIRP have proven and will prove impotent in escaping it. He advocates that “Debt Jubilee” [what @ZeroHedge calls “Helicopter Drops” of money] en masse to ordinary clients of the banks in Developed Economies is the only way to Collapse the galloping private debt and to stimulate the long craved Demand in developed economies. Nobel laureate @JosephEStiglitz and Hamid Rashid weighed in on the same issue –What’s Holding Back the World Economy?– while lamenting that most of the “Additional Liquidity” [expansion of Central Banks’ Balance Sheets via Assets Purchases or QE] returned to Central Banks’ Coffer as “Excess Reserves” instead of driving  up private “productive” investments through lending.

Perverse incentives are only one reason that many of the hoped-for benefits of low interest rates did not materialise…this implies that many non-financial corporations borrowed, taking advantage of the low interest rates. But, rather than investing, they used the borrowed money to buy back their own equities or purchase other financial assets. QE thus stimulated sharp increases in leverage, market capitalization, and financial-sector profitabilityWhen banks are given the freedom to choose, they choose riskless profit or even financial speculation over lending that would support the broader objective of economic growth.

More or less this sums up in short the trajectory of the course central Bankers [@FederalReserve, @ECB, @Bank_of_Japan_e, etc.] pursued and the “results” it actually obtained. Keen joined the issue by saying, “Hey Joe, Banks Can’t Lend Out Reserves“. He quotes following excerpt from “Joe’s” article:

As a result, excess reserves held at the Fed soared, from an average of $200 billion during 2000-2008 to $1.6 trillion during 2009-2015. Financial institutions chose to keep their money with the Fed instead of lending to the real economy, earning nearly $30 billion – completely risk-free – during the last five years.

Then he puts in his scathing observation next,

banks didn’t “choose to keep their money with the Fed instead of lending to the real economy”. They have no choice but to “keep their money with the Fed” and… watching academic economists and Central Bankers (the vast majority of whom trained as economists) tell the banks to “lend your excess reserves to the public, dammit!”, is akin to watching some delusional person in a playground watching two kids playing on a see-saw, and criticising them because they weren’t both up in the air at the same time.

Keen then embarks upon a lengthy demonstration of why “RESERVES” are “UN-LENDABLE”: Because doing so would mean BREAKDOWN of INVIOLATE Accounting Principle of DOUBLE ENTRY BOOK KEEPING, which BALANCES the BOOKS and ensures IRONCLAD ACCURACY.   His argument may be followed in the link to his article, but personally I found it frankly bit torturous to follow. On the point of “FACT” Keen is One Hundred Percent Right and Stiglitz wrong. First, the QE aims to buy assets [such as government bonds] from NON-BANKING financial institutions [NBFI] and NON-FINANCIAL institutions [NFI], who don’t hold accounts with central banks directly, and therefore, the money earned by them through sell of assets to central banks has to be deposited into their accounts held in commercial banks. The commercial banks have to MATCH the LIABILITY thus created on their books [money deposited by NBFI ] with an ASSET of EQUAL MAGNITUDE by crediting their RESERVES A/c held with Central Banks. Thus it is really a NIL-Efect game for commercial banks except increasing the size of their balance sheets, while the money spent by central banks in buying the assets returns to them if NBFI just sit tight on it. Of course, banks may earn interest on their reserves if central banks pay it, but then they too have to pay interest to NBFI on their deposits of matching size.

Had Stiglitz said, “…[Non Banking] Financial institutions chose to keep their money with the Fed [through Banks] instead of lending to the real economy,…“, then it would have been unexceptionable. 

Another simpler explanation from a “reputed” source:

Two misconceptions about how QE works Why the extra reserves are not ‘free money’ for banks While the central bank’s asset purchases involve — and affect — commercial banks’ balance sheets, the primary role of those banks is as an intermediary to facilitate the transaction between the central bank and the pension fund…  Importantly, the reserves created in the banking sector do not play a central role. This is because, as explained earlier, banks cannot directly lend out reserves. Reserves are an IOU from the central bank to commercial banks. Those banks can use them to make payments to each other, but they cannot ‘lend’ them on to consumers in the economy, who do not hold reserves accountsWhen banks make additional loans they are matched by extra deposits — the amount of reserves does not change.

The highlighted sentence in the above quote brings us to another issue that Keen holds is at the heart of financial crisis. Mainstream economists [notably @NYTimesKrugman] treat sacrosanct the LOANABLE FUNDS MODEL where the MONEY CREATION is the sole prerogative of the CENTRAL BANKERS and the SOVEREIGN. Commercial Banks act merely as an intermediary between those with excess money but no ideas how to use it -SAVERS/ DEPOSITORS- and those with ideas to use but no money -BORROWERS-; and steps-in to act as a LENDER on behalf of the depositors by pocketing the difference between interest paid and charged plus any processing charges as Fees. This LOANABLE FUNDS MODEL blinds Mainstream Economists to the “Mischiefs” Commercial Bankers are capable of according to non-conventional economists like Keen, who repudiated it decade ago. Just two years ago even a Central Bank like BANK OF ENGLAND published a paper to explain how COMMERCIAL BANKS CREATED MONEY [Money is LOANED INTO EXISTENCE]: Money creation in the modern economy.

The reality of how money is created today differs from the description found in some economics textbooks: • Rather than banks receiving deposits when households save and then lending them out, bank lending creates deposits. • In normal times, the central bank does not fix the amount of money in circulation, nor is central bank money ‘multiplied up’ into more loans and deposits.

Commercial Banks can in principal make LOANS AT WILL by a mere click of the mouse so to say: In Bank’s Ledger on the ASSETS-SIDE LOAN AMOUNT will appear, while it’s “DOUBLE [i.e. opposite] will appear on the LIABILITY-SIDE as DEPOSIT. However, this POWER is CIRCUMSCRIBED by the Monetary Policy that Central Bank follows. QE and ZIRP/ NIRP policies followed by central banks in last 7/8 years have done little to REFLATE the Real Economy and have managed to only distort almost all asset classes by Deforming Associated Risks.
When Banks Create Money simply by making out Loans, Why Did Banks Fail to Lend?
It’s the Economy Stupid.
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