My various scribblings today within the comment section of my previous post, ;-), have been my way of working through a different model than the “money multiplier model,” for which loans *need* existing deposits, and for which loans are *constrained* by the “reserve requirement” associated with existing deposits.
And yes, this uses a very simplified couple of illustrations in working with just the deposit made by one customer, but the exercise still serves the purpose of helping me to work through a couple of different models.
For one thing, I’m working with Bart’s comment under the Fullwiler post in mind, when he writes about reserves and about reserve requirements (requirements that are needed in association with demand deposits, yet are unrelated to the amount in loans that a bank may make):
I don’t feel like an expert anymore, but I did do quite a few years as a commercial banker in a large money center bank in New York….Yes in many countries a certain amount of reserves are known as “required reserves” because the regulator requires them to be maintained at the central bank and are based on customer DEPOSITS that a bank has on its balance sheet…in the US the ratio, which varies according to the type of customer deposit and the amount is set by the Federal Reserve Board and is known as Regulation D. …but THAT type of reserves has absolutely nothing to do with loans…And believe me, banks do not need reserves to make loans. Reserves in that sense can always be obtained from the market or the central bank, after the fact. –Bart
This comes into play when considering the “money multiplier” model, as well as an alternative to it, both of which I now feel like I know more about via my recent exposure to Steve Keen, Scott Fullwiler, etc., and my current “working through” (after the earlier working through a lot of us had done together here).
USING THE MODEL OF “THE MONEY MULTIPLIER”
…a deposit is needed first before a loan can be made.
A deposit is made, which gives the bank X amount of dollars in reserves (and yes, in the bank’s reserve balance with the Fed).
Further, according to this model, a “reserve requirement” of X dollars is set aside.
Then, a loan, which could only be created after deposit(s) have been made with the bank, would be constrained in its amount by the amount of that initial deposit *less* the reserve requirement.
So, by that model, let’s say $100 is initially deposited, and then, as a part of Bank 1′s reserve balance at the Fed, a certain percentage of that initial amount of reserves (let’s say 10%, which would be $10) is set aside as the “reserve requirement.”
Only now, in the “money multiplier model,” can the amount available for lending be determined.
This model says that in this example, $90 is available for lending.
Then, once the transfer has been made to the next bank, that bank receives that $90 and must, as a part of the reserve requirements, put $9 aside (10% in our case) within that bank’s account at the Fed.
For that bank, that then leaves $81 that can be loaned out, and so on.
The point for me of today’s “working through” has been to work my way through an alternative to the above model.
And the alternative model I use below (which I learned from Fullwiler, Keen, etc.) illustrates that no such constraint for bank lending exists – *even* if one takes into account “reserve requirements” associated with deposits.
USING THE (MMT/KEEN) ALTERNATIVE MODEL
…let’s use the same initial amount as in the example above:
$100 comes into the bank via a depositor, which is placed into Bank 1′s account at the Fed. And, of that $100, just for illustration purposes, let’s say $10 of that is set aside – as part of the “reserve requirement.”
In this alternative model, Bank 1 can still make a loan for $100 (or $500).
The “reserve requirement” in terms of this loan only means that when reserves are needed at the time of transfer from one bank to another, Bank 1 cannot use the $10 set aside for “reserve requirements.”
But it can use the available $90.
Up to this point, the two models, in the two examples shown, are similar. But from this point on, the two models diverge.
Bank 1 goes forward with creating a $100 loan. And at some point after it does so, when the time comes for a transfer from Bank 1 to Bank 2 (when the loan for $100 has been spent), Bank 1 will simply have to borrow the rest of the reserves needed ($10). And there are a few possible sources to borrow that sum of reserves from - via other banks, or the Fed…
So, in the alternative example, Bank 1 creates a loan for $100, regardless of the reserve requirements associated with the initial $100 deposit.
And now we bring the next bank into the picture:
Bank 2, after a transfer from Bank 1 has been made, now has $100 of reserves in its account at the Fed from that transfer, from which $10 is put aside as the “reserve requirement” associated with the $100 deposit.
And Bank 2, also, can make a loan for any amount, just like Bank 1 did, and so on…
IN CONCLUSION, ;-):
In the “money multiplier model,” the successive chain of events, from one bank transfer to the next, and so on, shows that, stemming from that initial $100 deposit, less and less dollars could be lent at each successive bank.
But today’s “working through” was not only about helping me to better understand the current, most widely accepted model, but also about helping me to better understand the alternative model that Keen and the MMT folks have exposed me to, in which the loan amount at each successive bank, associated with each successive transfer, is not related to the amount of the deposit made at any of them, nor to the amount of “reserve requirements.”
So for me, it was a helpful exercise, ;-)…