Keen and “The Mechanism”

  By Linda G | July 23, 2012 - 20:44 |

 

Hey, Mystic (and/or anyone else who might be interested). Okay, here’s at least one of Keen’s presentations (in writing – very recent, in fact) in which he includes the nitty gritty of double-entry bookkeeping to illustrate the mechanism of bank lending as it actually *increases* the money supply, and, therefore, aggregate demand (at least temporarily).

The accounting aspect is still way too new to me to quite follow him.  I don’t really know the stuff of debits and credits (in accounting terms, rather than common use terms).  But it sounds like you do, Mystic (and maybe some other folks here know accounting double-entry bookkeeping fairly well too).

So check out the link below, about half way down the page, where the heading reads, “The Mechanism.”

Below that, and following the lead of MMTers, Keen starts with a very simplified model, and then graduates to a more mixed, closer to real world, model.  And he shows how various factors relate, which includes the govt. sector (which brings into play the Central Bank – as it sort of straddles the govt. sector and the private banking sector and the private non-bank sector)… and which also includes the banking sector and, ultimately, the non-banking private sector.

And he gets into a discussion of the role reserves play in loan making and (I *think* this is what he’s saying) how they help to facilitate loans, but, more importantly, how they are basically conduits, rather than at the heart of the matter, of created money from the government sector getting out to the private, nonbanking sector and increasing the money supply (temporarily, until the loans are paid back).

As he says it (and works to illustrate):

The flow of loans by the private banking sector to the non-bank public is modeled as a transfer of the banking sector’s assets from reserves to loans, matched by the private non-bank sector depositing the flow in its deposit accounts. The two operations cancel each other out on the aggregate private banking sector reserve account, but increase the loan assets of the banking sector and the deposit liabilities at the same time. Reserves are thus needed to settle transactions between individual banks, and as a conduit for the government sector’s financial dealings with the private non-bank sector, but at the aggregate level are neither a requirement for, nor a constraint upon, private bank lending.” (emphasis mine)

If you (or anybody else who might be interested) get a chance to look at this (especially from about midway down and afterwards, with an eye out for the subheading, “The Mechanism”), I hope you’ll let me know what you think:

http://www.debtdeflation.com/blogs/2012/07/03/european-disunion-and-endogenous-money/

Written by: Linda G on July 23, 2012.
Tagged , , . Bookmark the permalink.
  • axionication1

    Hi Linda,

    Keen to look & will look. Over the weekend though.

    Thanks.

    Ps to self: what makes the mechanism so fascinating?

    • lgrinaker

      ;-)…

      Hey, axion.  yeah, what indeed? ;-).

      Linda

  • snedmeister1

    Nice find Linda…

    I think we are making this more difficult to understand than it needs to be though…..
    ( I am referring to some of your other comments on here too, but not criticising, honest..LOL  )

    I can tell you understand the function when written in words, the confusion is with the balance sheet, and I understand that confusion, I was facing it too, with Keens `banks CAN’T lend from reserves` quote…

    Take Nick’s balance sheet a few days ago, it implied loans were really made from reserves, but we know they are not…
    So what is wrong, and what is happening..??

    The deposits are what is increased when credit is made, and reserves are only needed when the money is spent….
    When the loan is made, the money supply increases ( because the deposits increase )…
    When we look in our bank, we don’t see £10,000 reserve levels, we see a £10,000 deposit….

    I think it is because we had an oversimplified balance sheet, which implied that the amount to be paid out was the reserve amount held by the bank…

    Even if that was the case, and I wanted to withdraw or spend the exact amount a bank had on reserves, the bank will have 30 days to wait for more deposits, or would borrow from another if needed…. Worse case, it could AND/OR, put up the newly created asset to the CB, and do a REPO for new reserves ( which the CB will always provide on request, it is their job )…..

    I think I also get the Keen `Can’t lend from reserves` as well now… 

    Bottom line Linda, you clearly understand the function in words, but not how it looks on a balance sheet….
    Is that such a big deal..?? :)
    Just look at some of Keen’s equations…!!!

    The bloke is just not normal, but all it shows ( I think ), is what you already know in words…
    Don’t give yourself a hard time, that’s his full time job, this is an interest for us..!!!

    • http://overthepeak.com/wordpress/ Mystic

       ”I think it is because we had an oversimplified balance sheet, which
      implied that the amount to be paid out was the reserve amount held by
      the bank…”

      I jolly well hope not~!
      (but even if it did, it would not make any difference)

      • snedmeister1

        :)

        feeling more up to it today Nick…??
        I jolly well hope so..!!! 

        It wasn’t a snipe shot, that comment, just an interpretation….
        If it’s wrong, as you say, it doesn’t make any difference….

        • http://overthepeak.com/wordpress/ Mystic

           A bit better today.
          Happy everyone is posting, thinking and chatting, today ….. it takes onus off me to shove things along.
          My new USB hub seems to work …. which is good.
          The sun is shining and I am going to go and have a siesta under a big parasol up on the land.

          (I still have a little nagging desire to hit someone though)

          • lgrinaker

            Sounds like a good plan (while that last part sounds like a good feeling to keep safely expressed within parentheses, ;-)). 

            On another note, I’m sorry to hear that Mrs. Mystic has had some issues over this past while as well.

            I wish you both well…

            Linda

            • http://overthepeak.com/wordpress/ Mystic

               Thank you Linda.  Mrs M. may tell you about it one day.

      • lgrinaker

        I do feel like I’m slowly, but surely getting a better handle on it.  And yes, from what I’m beginning to understand, the reserves are definitely a part of it.  Bank reserves are definitely the most immediate source (although not the primary source) for funding the loan.

        One of Keen’s main points is that lending does not take away spending power from existing depositors; that, instead, funds for lending ultimately come from the govt. sector.  It’s newly created money from the govt. sector, but because it’s put into the form of a loan, it’s not *net* new money – it is supposed to be repaid in full (fully taken out of the system). 

        So in Keen’s model, the govt. sector is the source for both newly created money spent into the system that *does not* have the requirement to be paid back *and* newly created money for the purpose of loans, money that *does* have the requirement to be paid back.

        This is the “vertical integration” that Keen’s model now accounts for (with the help of MMT folks, who also helped him with double entry accounting, ;-)).

        Keen’s model now provides for an integrated system for lending that includes the Central Bank/Treasury, and its infinite capacity to create fiat currency, the private banks, and their capacity to create loans/deposits, and banks’ reserves, which allow for the necessary conduit from the fiat creation at the top (the govt. sector) to the end-user (private customer), who signs a loan agreement and ultimately spends the loaned, newly created fiat money into the non-bank private sector (with the understanding that those funds will need to be paid back).

        Linda

        • http://overthepeak.com/wordpress/ Mystic

           It depends when you specify that the loan is being funded, no~?
          When is the loan `funded`~?
          I would say that it is never `funded` as such.  In one instant, the moment of the loan, it is just typed in ….. no regard to funding at all.
          The other instant that it could indirectly say to be funded, would be when your bank has to pay another bank for the loan you have just spent.  In that case it is always funded from reserves.

          The rest of your comment is all new to me (and for the moment makes no sense at all).
          The only Keen I have on a tab, waiting to watch/listen to is `Just banking presentation`.
          (if it is not in that one, would you please link me up to the Keen info please please).

        • http://overthepeak.com/wordpress/ Mystic

           I had read that before …….. as far as the equations.  When I see equations, I go away.

          It was more government than banking, from what I could understand.

          Governments spend money (paying wages etc.) …… that money goes into employee bank accounts and is balanced by equivalent cash assets on the bank’s books.  (shrug)

          I could not follow the banking process in Fig.9 (I just couldn’t).

          • lgrinaker

            Well, I thought I was beginning to glean something regarding “vertical integration,” but now I don’t think so, ;-), having read a more recent post from Keen (in his ongoing blog discussion w/ Mish):

            http://www.debtdeflation.com/blogs/2012/07/14/mish-steve-debate-steve-says-i 

            I read the above response from Keen, in which he again asserts the private banks’ own power – in aggregate – to create new money (albeit temporary), which increases the money supply (rather than just moves existing money around from the “patient” to the “impatient”)…nothing “vertical” about his model, at least in this particular discussion…

            So I’m quite content to simply say, nope, I don’t have a good handle on this at this time.  Maybe some day…

            I have to say, it’s rather comforting to see (within the comment sections of various posts I’ve been reading today) that I’m definitely not the only one who is struggling with this, ;-).

            So perhaps I’ll be able to put this aside for now, at least for a time…

            Linda

            • http://overthepeak.com/wordpress/ Mystic

               Hello Linda,
              The main thing that strikes me a strange beyond words …… is that it is looking like this is all being worked out for the first time.
              It is not as though anything fundamental has changed in banking in banking for decades, but the information is just not Googleable~!?

              My management head is shouting – `Who’s job was it to know about these things~!?`.

              • axionication1

                Sorry for jumping in, Nick/ Linda.

                Keen/Shedlock setting themselves up as modern day Keynes/Hayek’s. So much debate, so little time to get into…

                Have obliquely been looking into all of this for a few months now…’strange beyond words’ eh… downright spooky to me…!

                • http://overthepeak.com/wordpress/ Mystic

                  Hello Axion,
                  As I said to Linda ….. It is spooky that it is spooky.  This is not quantum physics, this is the same banking system that the world has used for decades …… and we don’t seem to even know how to start to describe how it works (within the economy)~!

                  • lgrinaker

                    One thing I know at the moment is that your little illustration of 5s has been very important for me, even with the headache it’s caused me, ;-).

                    Because you’re right.  It’s important that that loan agreement (added onto the asset side of the ledger) can not be what is used to “cover” when the deposit on the liability side is drawn down.

                    As has been noted, yes, the loan/deposit can be created without using reserves beforehand, but even as Keen notes, reserves are used when there is a draw on the deposit.

                    Now, I also understand it when he says that *in aggregate*, there is not a change in reserves because, as you also mentioned in your example, somewhere (likely at another bank), the spent money (for whatever) would likely end up in a bank with a deposit (as a liability) and the money (for bicycles) as reserves (asset).  So that in that secondary exchange, the reserve used is cancelled out, at least in aggregate, by the reserve gained.

                    ~~~~

                    (ah, I foresee another very long comment coming, so I think because I still want to “think this through at this time,” I’m going to go for a cheap trick and simply start another comment (or two), rather than try to put all of this in a single comment space, ;-)

                    Linda

                    • http://overthepeak.com/wordpress/ Mystic

                       Yes Linda.  Here we bump into another explanatory angle – `pretend there is only one bank`.
                      Go on, get your pencil out again~!

  • lgrinaker

    That’s a very reassuring comment, Sned, thank you, ;-).
     
    Yeah, Jasp just posted a link within an earlier thread that was part of a blog entry from this past January, in which somebody (an MMTer) helps Keen with his accounting because, apparently, Keen was way off with it at that time.  (I love it!)

    Here’s Jasp’s find from this past January:

    http://www.3spoken.co.uk/2011/12/double-entry-view-on-keen-circuit-model.html
     
    It’s really cool to learn how much of a struggle Keen has had in getting a handle on accounting, specifically double entry bookkeeping, as well, ;-).  I’m not the only one who’s needed help with it!
     
    And in that blog entry by Neil Wilson, commenters bring up the need to “vertically integrate” what is current with the model in that January blog entry.  Interestingly, I think that evolution seems to have occurred by the time we get to Keen’s blog entry I linked to in this post, which is dated very recently, July 3, 2012 (about the time of the MMT/Keen gathering and video presentations Mystic posted recently).

    Linda

    • axionication1

      Linda, delve Deep into the history of debk if you get a chance.

      Pacioli & his acquaintances. I think you will really enjoy.

  • lgrinaker

    (cont. from another place in this thread; I’m doing so here because the thread was beginning to become too “skinny” over there, ;-))

    Okay… so in taking up that earlier thread, which, while still using Mystic’s illustration of the 5s, and another bank, we can see that in aggregate, there hasn’t been a change in reserves (the draw down in reserves in the first bank has subsequently become a rise in reserves in the 2nd bank – the seller of bicycles has made a deposit with her money in this 2nd bank, ;-).

    ~~~~

    *However*, that can’t be the end of the story regarding reserves at the original bank where the loan was made. (Still using the illustration of the 5s that Mystic created.)

    For (and I wish I could include a table here, like you did in your video, Mystic), as it stands now, we are still left with a deposit account hanging (the counterbalance on the asset side, still the loan that can’t be used for drawing down the deposit if and when the depositor makes a demand for the deposit). And that’s because, the reserve that was created when the original depositor set up their account has been used for the person who took out a loan and has drawn down his/her deposit.

    At this point it may be that that depositor is not interested in drawing on his/her deposit, such that reserves aren’t needed, maybe not even for the full length of the loan.

    So, I want to first look at that scenario (which I’ll continue in the next comment – this cheap trick of mine so that I don’t put a whole long train of thought in a single comment space, although I’m still basically writing a very, very long comment again, ;-)):

    Linda

    • lgrinaker

      (cont.)

      (cont. from my comment above)

      Okay, the loan has now reached maturity. It’s time for it to be fully paid back. (For simplification, I’ll just say it was a no interest loan, so that we’re not attending to equity, etc., and that there there were no payments needed until the time of maturity.)

      Let’s say it was a year-long loan, and the year is up. And the debtor has the ability to pay back the loan in full.

      ~~~~

      Well, at this point, there still remains that “patient person” who has not drawn down their deposit, so that the deposit liability for the bank still stands just as it did back when that other person’s loan was made.

      ~~~~

      I would say that since it’s (as our illustration currently stands) the loan agreement that, as this bank’s asset, is counterbalancing the “patient person’s” still remaining deposit (not yet drawn upon), the loan agreement would not be simply deleted/destroyed.

      Instead, it would be converted from a paper agreement to the money that the debtor is now paying back.  That doesn’t change the value of the asset, it only converts the asset from a loan agreement into money that can be used as reserves.

      ~~~~

      Okay, in this particular scenario, we are basically back to the point we were when we simply had a “patient person” and his/her undrawn deposit account as a liability for the bank and money that can be used as reserves on the asset side of the ledger.

      ~~~~

      But there’s something that has happened in the mean time, something that Paul Krugman hasn’t accounted for in his “patient person”/ “inpatient person” scenario…

      (to be continued, ;-))

      • lgrinaker

        (cont.)

        Okay, to take up where I last left off…

        But there’s something that has happened in the mean time, something that Paul Krugman hasn’t accounted for in his “patient person”/ “inpatient person” scenario…

        ~~~~

        We have to look at the aggregate to see this.

        For somewhere in the existing economy, the original debtor has gained enough money to pay off his/her loan (and I’m assuming here that the debtor has not had to take out another loan to pay off the original one, but that instead, the debtor has received these funds free and clear).

        ~~~~

        At this point, I’m going to make it very simple and use our original bicycle seller and that 2nd bank that the bicycle seller put his money into.

        ~~~~

        And I’m going to say that with the money from the original loan, the debtor who bought the bicycle from the bicycle seller used that bicycle to become a “small package delivery girl” (hey, I happen to *like* political correctness, ;-)).

        And, heck, let’s say that the bicycle seller and the bicycle buyer are neighbors.  Well, as a  delivery girl, let’s say that the bicycle seller hires this delivery girl to deliver some newly made bicycle bells to some of his existing customers, ;-). 

        ~~~~ 

        Okay, the point is:

        The bicycle seller draws from his account $5 (such that the 2nd bank now cancels out the deposit and reserves earlier created when the bicycle seller put the debt-money from the original debtor into that 2nd bank).

        ~~~~

        In this example, at least, the temporary *new money* in the economy due to that loan can be tracked to the 2nd bank and the additional spending power it provided to the bicycle seller.

        ~~~~

        The original debtor was under contract to pay back the money she spent.  However, in the aggregate, we can see that when the bicycle seller spent that money, it was *new money* to them (at least whatever profit the bicycle seller made from the sale of the bike). 

        ~~~~ 

        It all gets paid back in the end (the original debtor pays back her debt), but in the mean time, the money, the spending power, created by the loan, provided free and clear usable income for the bicycle seller (okay, at least via the bicycle seller’s profit on the sale of the bike).

        ~~~~

        And the original bank that provided the loan is back to where they first started before the debt was made:

        $5 on the asset side in usable reserves (converting the original loan agreement to money via repayment)  & $5 on the liability side in the undrawn deposit account of “the patient person.”

        ~~~~

        The above isn’t the only scenario.  It can also be done without a ”patient person.”  It could be done with the original person that created a deposit account due to bringing money into the bank wanting to draw on his deposit too.  We could play out that scenario by working with a loan by the bank, for example.

        But in the end, we’d come back to something very similar once the loan is paid back.  We’d have usable reserves on the asset side (the loan being converted from a piece of paper that was the loan agreement into spendable reserves once the loan has been paid back).  And we’d have the bank’s own loan on the liability side, which the bank is capable of covering, just like with the above scenario, when the bank once again has usable reserves to draw upon to counterbalance the deposit that a customer can draw upon.

        ~~~~

        Of course, this is very simplified, but it does bring in the aggregate (as your earlier illustration did, Mystic), and that’s where, when we play out the illustration further (even if remaining simplified), we can see the expansion of the money supply taking place… until the debt is repaid.

        Linda

        • lgrinaker

          (Finally! the final part, ;-)… Part 5 of 5: cont. from my above comment)

          The above isn’t the only scenario.  It can also be done without a “patient person” as the original bank customer.

          ~~~~

          It could be done with the original person that created a deposit account (with money he brought into the bank) wanting to draw on his deposit too. 

          We could play out that scenario by working with a loan by the bank, for example.

          ~~~~

          But in the end, we’d come back to something very similar once the bank customer’s loan is paid back. 

          We’d have usable reserves on the asset side (the customer’s loan agreement being converted from a piece of paper into spendable reserves once the loan has been paid back). 

          And we’d have the bank’s own loan from another bank (or from the CB, it doesn’t matter) on the liability side, which the bank is now capable of repaying.

          This ends up just like with the above scenario, when the bank once again has usable reserves to draw upon to counterbalance a liability (in this case, the obligation to pay back the loan the bank itself took out from another bank).

          ~~~~

          Of course, this is very simplified, but it does bring in the aggregate (as your earlier illustration did, Mystic), and that’s where, when we play out the illustration further (even if remaining simplified), we can see the expansion of the money supply taking place… until the debt is repaid.

          Linda

          • http://overthepeak.com/wordpress/ Mystic

            I still don’t understand this – “We’d have usable reserves on the asset side (the customer’s loan
            agreement being converted from a piece of paper into spendable reserves
            once the loan has been paid back). “  ??

            • lgrinaker

              I just put up a step by step illustration in response to your initial response.

              Still, it would work much better in a video, rather than my long written step-by-step illustration (even with some “tables” in the illustration).  But it does at least play through correctly, I believe, and show that there really is an aggregate *increase* that comes about due to a loan, temporarily.

              And it does show, I believe, that the “fractional reserve” model of lending isn’t necessary.

              Linda

               

              • http://overthepeak.com/wordpress/ Mystic

                 I’m having doubts over one of my 5 steps.
                I will go through yours in the morning…..when I am fresher….and more up to that sort of thing.
                Hello Linda~!

                • lgrinaker

                  Yes, it’s late where you are (still mid-day for me).

                  And in the mean time, I’ve tried to clarify some of my writing in my step-by-step comment above.

                  I do, however, feel pretty confident with it (at least for now).   But maybe you’ll bring up something that will change my mind.

                  Do know, though, as I mentioned elsewhere, it was your initial “being stumped” by that loan agreement that cannot be used at the time that the debtor seeks to draw down his/her deposit, such that cash – whether in paper form or electronic form – has to be found via other assets in the bank… that is something that I think is *key* here, a problem that has to be dealt with in trying to understand bank lending, whether trying to understand Keen’s model, or “the fractional reserve” model, or any other model.

                  And your taking your beginning illustration as far as you did has helped me tremendously.  And that’s even if I’m still off the mark.  That’s because I think your illustration is correct, and has to be dealt with, even though it threw me for a loop in trying to take it into account, ;-).

                  Have a good night, Mystic, ;-).

                  Linda

    • http://overthepeak.com/wordpress/ Mystic

       No, too much Linda.
      You cannot mix Mystic 5′s and Linda 5′s and Keen and Krugman.  You just can’t.
      No one will be able to follow you.  (Well, I can’t ….. (and I’ve got a brain the size of a planet)).

      • lgrinaker

        This time, I actually am fairly confident…  that I’m beginning to “see” the lending aspect of banking along the lines that Keen “sees” it. 

        (And, like he says, it doesn’t have anything to do with “fractional reserve banking”.  But looking at what happens in *aggregate* is important, even if we use a very simple example.  It doesn’t work if we use just the bank at which the loan was created.)

        It’s just that it would be much easier to follow if I could include tables like you did, to illustrate the example in something more than words. 

        Okay, I’ll try doing that (but not as nicely as you were able to with your nice big tables and slash marks, ;-).)

        Here goes…

        ~~~~

        1.  Using the scenario of “the patient person” as the initial customer who comes into the bank with money in order to set up a deposit account with the bank, we start just like you did, with –

        5/5

        ~~~~

        2. Just as in your illustration, a 2nd customer comes in asking for a loan.  And just as was the case in your illustration, we create a loan agreement on the asset side and a deposit on the liability side – and just as in your illustration, we can do so without yet touching reserves.  Now, we have:

        5/5
        5/5

        ~~~~

        3. Just like in your illustration, the loan customer wants to draw on his deposit.  And just like in your illustration, the bank can’t use the loan agreement to fulfill the demand for spending money.  So, the bank (in this simplified illustration), uses the money (the reserves) brought in by the original customer.  Now, we have:

        [blank]/5  – the [blank] being the same as the crossed out 5 in your illustration.

        5/[blank]

        ~~~~

        4. Now, we’ll move into the illustration you spoke of in your video, only we’ll write it out here.

        Here, we’ll bring into the picture just one new line of entries.  We’ll do that when we include what happens at the 2nd bank.  T

        This illustrates what happens when the debtor from Bank 1 uses, spends, the money made possible by the creation of the loan.

        And we’ll stick with your example.  The debtor buys a bicycle from a bicycle seller.  

        And the bicycle seller becomes a customer at Bank 2.  Now, we have:

        Bank 1 (just as we left it above):

        [blank]/5
        5/[blank]

        ***AND***

        Bank 2:

        5/5  (the bicycle seller places his money in bank 2, which creates a cash asset (reserves) and a deposit liabilty for Bank 2)

        ~~~~

        5.  Now, we’re at a point at which the original debtor is gaining the money needed to pay back the loan she got from Bank 1.

        And we’re staying with two persons already in our illustration, the bicycle seller and the original debtor.

        The debtor is now using the bike she bought with the loan money in order to make income.  Let’s say she has become a delivery girl.  And to keep it all very simple, let’s say the bicycle seller has hired her.  (She delivers some bells to some of the bicycle sellers customers.)

        And let’s say she has now done enough work to have earned $5 from the bicycle seller.  And it’s payday.

        ~~~~

        6.  At this point, the debtor can now pay back her debt because the bicycle seller has paid her.

        So this is how that plays out at Bank 1 and Bank 2:

        Bank 1:

        5/5 

        The paper loan agreement has now been converted into cash reserves; and is available to counterbalance the demand deposit (still not drawn from) created when the 1st customer came into the bank (we can call this customer a “patient person” because while the loan for the other customer was still outstanding, this original customer never needed money for spending). 

        So at Bank 1, we’re basically back to where we started before the loan was ever made.

        Bank 2:

        [blank]/[blank] 

        The bicycle seller uses the $5 from his account to spend for the services he needed, free and clear.  (He didn’t need to take out a loan to pay for the service of delivering bells to his customers.)

        And it’s that payment – to our original debtor - that the debtor now has that enables her to repay Bank 1 (see above). 

        ~~~~

        7.  So that once the loan is paid back, even in the aggregate, we are back to where we started:

        Bank 1:

        5/5

        Bank 2:

        [blank]/[blank] 

        For the purposes of this illustration, we’ll say that the bicycle seller closes his account once he uses the money to pay for the services he needed.

        So that we really only have what we had at the beginning of the illustration before the loan ever took place:

        Bank 1:
         
        5/5

        ~~~~~~~~~ IN CONCLUSION ;-) ~~~~~~~~~~

        8. It’s what happened ***IN THE MEAN TIME*** that is key to the “new money” Keen insists is created by the loan, at least temporarily.

        For a while, in *aggregate*, via the two banks in our illustration, because of the loan, the banking sector has:

        *****$10 value in its assets (balanced by $10 value in liabilities)****

        Bank 1:

        [blank]/5
        5/[blank]

        Bank 2:

        5/5

        9.  If we only had that initial bank customer who, at some point decided to buy a bicycle,

        ****the aggregate would never be more than $5****

        As can be seen here:

        Bank 1:

        [blank]/[blank]  The original customer draws down his deposit in order to by a bicycle.

        Bank 2:

        5/5  The bicycle seller puts the money into Bank 2 creating a $5 asset and a $5 liability.

        And that leaves, in aggregate, $5 less than the scenario with a loan in play.

        ~~~~

        Yep, this would work much better in video form, but at least I’ve included tables to the illustration (as sad as they are in this format, ;-)), rather than just leaving it in words.

        Linda

        • lgrinaker

          Just as an “addendum:”

          The above illustration uses an initial customer who does not seek to draw down his deposit account during the life of the second customer’s loan.

          But a second scenario, with an initial customer who *does* seek to draw from his deposit account, can be illustrated too.

          Bank 1 could take out a loan (it doesn’t matter where from for the purposes of this simplified illustration - either another bank or the CB) in order to have the cash to cover the withdrawal of funds by the debtor, which the paper loan agreement can’t be used for.

          I won’t try to show the steps in that scenario, but in the end, the result would be the same – with the use of the bicycle seller and Bank 2, and the original debtor being able to repay the loan to Bank 1, Bank 1 would then still end up with cash reserves as an asset, rather than the original loan agreement, that would enable them to pay off their liability (in that scenario, Bank 1′s liability would be the loan agreement made by another bank). 

          Linda

        • http://overthepeak.com/wordpress/ Mystic

           I’ve just finished my first Columbo, so I have some active braincells to spare.
          Okay.  Let’s go -
          1. Patient person starts us off with a good 5/5.
          2. Loan man gives us the stacked 5/5′s.
          3. OK for blank/5 …  blank/5 (this is slightly different as it is taken out as cash (not the longer way round when it is taken out by cheque.  Which was to the bicycle shop / bicycle shop’s bank / via the central bank to the reserves or, as in this case, the patient person’s deposit cash held on the asset side).
          4. OK. Now you are going to take the longer route, but via cash.  5/5 to the 2nd. bank.
          5. Good for her/him
          6. And we hit the wall – “The paper loan agreement has now been converted into cash reserves”~??
          I think you have rushed on a bit there, with no explanations, but I follow you to getting back to where we started.

          I am strangely happy that my 5′s have lasted the course and my throwing something in the air still works.

          They have thrown lots into the air (a bubble you could say), and desperately want to throw some more stuff up there; but, bubble blowing is a group sport and individually they know it is a crazy thing to do …….. and it only works if they throw together.

          Did you follow me ….. following you …… following Keen etc. and on~??

          • lgrinaker

            Ah, you’re back!

            (I’ve been fiddling with what I originally wrote, so you may want to check that again - if you can, or are at all inclined to, wade in there again.)

            And I will now play with what you’ve newly brought into the sandbox, ;-).

            However, for me, I don’t think I’ll have anything new to contribute to our sandbox play until at least tomorrow! ;-)

            How did you reactivate your brain cells so quickly?!? ;-)

            Linda

          • lgrinaker

            One key mistake I think I made in trying to “get” this earlier was this:

            I was trying to see repaying the loan like the paying of taxes (MMT payment of taxes, anyway).

            I was visualizing both the money coming back to Bank 1 (via repayment from the debtor) & the loan agreement as being destroyed at the time of repayment.

            But now, I don’t think that’s correct. 

            (I still think in those terms regarding taxes:  Via MMT, I think of the payment of taxes in the sense that that is simply a drain from the money supply, and that such payment does not constitute funds coming into the treasury to be used for funding subsequent govt. spending.)

            ~~~~

            Now, I think that when the debtor brings funds back to the bank for repayment, those funds become a part of the bank’s cash reserves (which can be used immediately for anything the bank needs reserves for), while, at the same time, the loan agreement is inactivated (or whatever they do to the “piece of paper” that signifies a promise of repayment, once that promise has been fulfilled).

            That doesn’t make for any net addition to the bank’s assets.  On the asset side of the bank’s ledger, it just replaces cash reserves (repayment for the cash earlier withdrawn by the debtor) for the loan agreement.  The bank’s books remain balanced.

            Linda

          • lgrinaker

            Mystic wrote:

            “I am strangely happy that my 5′s have lasted the course and my throwing something in the air still works.”

            That makes all the sense in the world to me.  Those little 5s and the thinking you brought to the table with them has made a *huge* difference for me.

            I couldn’t stand them at first.   

            (Well, you know what I mean…  They really furrowed my brow - but in a good way, ;-) because I knew that my furrowing brow, although very uncomfortable at first, meant I had “some thinkin’ to do” if I were to have any grasp of banking and lending… to account for those little 5s and what they showed *has* to happen when a loan is involved… any model about bank lending would have to account for what was happening to those little 5s, ;-)).

            Linda

            • lgrinaker

              And guess what?

              I *think* that your little 5s also show that the “fractional reserve model” is not needed to account for a (temporary) rise in assets via lending.

              We can see that from our 2 little scenarios with those little 5s used here (see also my “addendum” somewhere below my first scenario).

              ~~~~

              In our first (fully illustrated, ;-)) scenario, Bank 1 used the full $5 of cash reserves first brought into the bank by our initial customer, “the patient person,” in order to pay for the withdrawal made by the second customer, the debtor.

              In our second scenario (see addendum), Bank 1 takes out a loan from another bank in order to have the cash reserves available for the debtor to withdraw funds from her deposit.

              In both scenarios, when Bank 2 (to allow for a sense of the aggregate of the banking sector) is brought into the picture, we can see that the overall assets on both banks’ balance sheets rise during the interim before the loan is paid back.

              And the “fractional reserve banking model” is not needed to illustrate that overall increase.

              ~~~~

              Further, we can also imagine that as more and more loans (and we can still use those little 5s, ;-)) are taken out and paid back, if the rate of lending is higher than the rate of repayment, then bank assets will be rising as that happens, and it’s not hard to imagine, and just from these simple scenarios, that assets can rise *a lot*. 

              And again, there is no need for the “fractional reserve banking model” to explain that.

              All that’s needed is a higher rate of lending in relation to the rate of repayment.  And Keen adds to that the fact that acceleration and deceleration in lending can impact the system as well.

              ~~~~

              Those little 5s also showed that it’s not necessary for any of the bank customers to “not spend” while the loaned money is in play.  That may happen, that we have a “patient person” who has provided cash reserves that can be used when debtors withdraw from their deposit account. 

              But that doesn’t have to happen (as the second scenario shows, see “addendum” - when both customers draw down their deposit accounts and Bank 1 takes out a loan…)

              When looked at in aggregate in the event of banks needed to take out loans themselves in order to fund withdrawals, as long as the CB is there as a part of the whole of the banking sector, with unlimited capacity to truly create funds for lending, lending by commercial banks does not have to deny spending power to one (or some) customers in order to provide it for another customer (or other customers, plural). 

              (They’re may be other and important reasons to deny some customers loans, but those would not include that of commercial banks lacking the capacity to get the funds needed for withdrawals from their deposit accounts by debtors.)

              Linda

              • lgrinaker

                Further, we can also imagine that as more and more loans (and we can still use those little 5s, ;-)) are taken out and paid back, if the rate of lending is higher than the rate of repayment, then bank assets will be rising as that happens, and it’s not hard to imagine, and just from the use of these simple scenarios, that assets can rise *a lot*.
                 
                And again, there is no need for the “fractional reserve banking model” to explain that.

                All that’s needed is a higher rate of lending in relation to the rate of repayment. 

                And Keen adds to that the fact that acceleration and deceleration in lending can impact the system as well.

                ~~~~

                Those little 5s also showed that it’s not necessary for any of the bank customers to “not spend” while the loaned money is in play. 

                That may happen, that we have a “patient person” who has provided cash reserves that can be used when debtors withdraw from their deposit account. 
                 
                But that doesn’t *have* to happen (as the second scenario shows, see “addendum” – when both customers draw down their deposit accounts and Bank 1 takes out a loan…)

                When looked at in aggregate (which includes the potential for banks to borrow not just from other commercial banks, which banks often do, but also from the Central Bank), in the event that banks need to take out loans themselves in order to fund withdrawals… as long as the CB is there as a part of the whole of the banking sector, with unlimited capacity to truly create funds for lending… then lending by commercial banks does not have to deny spending power to one (or some) customers in order to provide it for another customer (or other customers, plural).

                (They’re may be other and important reasons to deny some customers loans, but those would not include that of commercial banks lacking the capacity to get the funds needed to pay for withdrawals by debtors.)

                Linda

                • lgrinaker

                  Also, those little 5s show that it’s not necessary for any of the bank customers to “not spend” while the loaned money is in play, as Krugman seems to insist (while Keen insists that Krugman is wrong on that).
                   
                  That may happen, that we have a “patient person” who has provided cash reserves that can be used by a bank when a debtor make a withdrawal.  

                  But that doesn’t *have* to happen (as the second scenario shows, see “addendum” – when both customers draw down their deposit accounts and Bank 1 takes out a loan…)

                  When looked at in aggregate (which includes the potential for banks to borrow not just from other commercial banks, which banks often do, but also from the Central Bank, with its unlimited capacity to provide/create funds for lending), we can see that lending by commercial banks does not have to deny spending power to one (or some) customers in order to provide it for another customer (or other customers, plural).
                   
                  (There may be other and important reasons to deny some customers loans, but those would not include that of commercial banks lacking the capacity to get the funds needed to pay for withdrawals by debtors.)

                  Linda