In last week’s article, we explained how the yield curve could cause GDP to contract in The Yield Curve and GDP – a causal relationship. Some of our readers suggested the analysis was wrong on back of an outdated view of modern money creation. The critics claim modern banks are not dependent on central bank reserves to create additional money; citing a Bank of England article from 2014 (which we have been well aware of)
[A] common misconception is that the central bank determines the quantity of loans and deposits in the economy by controlling the quantity of central bank money – the so-called ‘money multiplier’ approach. In that view, central banks implement monetary policy by choosing a quantity of reserves. And, because there is assumed to be a constant ratio of broad money to base money, these reserves are then ‘multiplied up’ to a much greater change in bank loans and deposits. For the theory to hold, the amount of reserves must be a binding constraint on lending, and the central bank must directly determine the amount of reserves. While the money multiplier theory can be a useful way of introducing money and banking in economic textbooks, it is not an accurate description of how money is created in reality. Rather than controlling the quantity of reserves, central banks today typically implement monetary policy by setting the price of reserves – that is, interest rates. In other words, the article suggest commercial banks themselves determine the amount of reserves, not the central bank. We do not dispute that claim; on the contrary we have argued that in today’s world that is a very accurate description of how commercial banks operate. We have said that the market for money is the only market in the whole world which operate on Keynesians principles; where demand create its own supply and not vice versa.
This post was published at Zero Hedge on 11/09/2015.
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