Smart Money
June 8, 2015 9:14 am
BoE paper finds theoretical view of lenders is out of date
©Getty Images
Are
banks mere intermediaries between savers and borrowers, or prime movers
in the monetary world responsible for the credit and money creation
that drives the economy? Many books on finance describe them as the
former, but central banks believe commercial banks have a much more
important function.
It is surprising that there is any debate about
how banks work: surely it is crucial to an understanding of the drivers
of both the financial system and the economy. But as a working paper
by the Bank of England published at the end of May points out, there is
an enormous gulf between how mainstream economic theory views banks and
the reality, as described by the authors of the paper, Zoltan Jakab and
Michael Kumhof.
Banks
do not simply lend out money deposited by savers, the so-called
loanable funds model that most economic textbooks propound. Instead they
create deposits when they make loans, effectively expanding the money
supply. They create most of the money in circulation, and are limited in
how much they create mainly by their own assessment of the implications
of new lending for their solvency and profitability.
Central banks have limited control over how much money is pumped into the system in this way, and supply whatever reserves are required. The idea that commercial banks multiply money created by the central bank is plain wrong.
“Central banks are committed to supplying as many reserves (and cash) as banks demand” at the target rate of interest, in the interests of financial stability, the paper says. “The quantity of reserves is therefore a consequence, not a cause, of lending and money creation.” And in any event, banks cannot lend central bank money on to non-banks.
The paper’s description of how banks work can be found in many central bank publications, say Mr Jakab and Mr Kumhof. More challenging is to incorporate it into the models used in macroeconomics. A failure to do so leads to a big underestimate of the effects of changes in bank lending on the real economy.
The authors’ models predict “changes in the size of bank balance sheets that are far larger, happen much faster and have much greater effects on the real economy” in response to shocks affecting the creditworthiness of bank borrowers than if banks are modelled as intermediaries.
They also predict that bank lending will be procyclical, which means a boom in credit creation in good times and a rapid pullback in a downturn. The loanable funds model, on the other hand, predicts lending will be countercyclical, balancing out what is happening in the economy.
In addition, the paper predicts banks will react to adverse circumstances by cutting back on lending rather than just charging more, as the mainstream models expect.
This is by no means the first publication on the subject of money creation by banks, although the modelling may be novel. A wider appreciation of the importance of bank money creation and its role in the build-up of private sector debt to record proportions ahead of the global financial crisis has emerged since 2008. It is not unusual, though, to meet investment professionals for whom this is a challenging idea.
It is important to widen understanding, says Mr Dyson, because if regulators and policy makers are basing their views on the risks of another crisis occurring, or what might lead to one, on a model that shows banks will stabilise the economy, mistakes are likely.
Investors and money managers are also better equipped with a clear view of the unique ability of banks (and only banks) to create money by making loans, and how this can lead to instability. The problem is there are too few controls over how much they lend and for what purpose.
Central banks have limited control over how much money is pumped into the system in this way, and supply whatever reserves are required. The idea that commercial banks multiply money created by the central bank is plain wrong.
“Central banks are committed to supplying as many reserves (and cash) as banks demand” at the target rate of interest, in the interests of financial stability, the paper says. “The quantity of reserves is therefore a consequence, not a cause, of lending and money creation.” And in any event, banks cannot lend central bank money on to non-banks.
The paper’s description of how banks work can be found in many central bank publications, say Mr Jakab and Mr Kumhof. More challenging is to incorporate it into the models used in macroeconomics. A failure to do so leads to a big underestimate of the effects of changes in bank lending on the real economy.
The authors’ models predict “changes in the size of bank balance sheets that are far larger, happen much faster and have much greater effects on the real economy” in response to shocks affecting the creditworthiness of bank borrowers than if banks are modelled as intermediaries.
They also predict that bank lending will be procyclical, which means a boom in credit creation in good times and a rapid pullback in a downturn. The loanable funds model, on the other hand, predicts lending will be countercyclical, balancing out what is happening in the economy.
In addition, the paper predicts banks will react to adverse circumstances by cutting back on lending rather than just charging more, as the mainstream models expect.
This is by no means the first publication on the subject of money creation by banks, although the modelling may be novel. A wider appreciation of the importance of bank money creation and its role in the build-up of private sector debt to record proportions ahead of the global financial crisis has emerged since 2008. It is not unusual, though, to meet investment professionals for whom this is a challenging idea.
Ben Dyson, head of research at Positive Money,
a campaigning movement, says the mainstream loanable funds view of
banks tends to be promulgated in the finance sector, and among bankers
themselves, pointing to the standard textbook from the Chartered Bankers
Institute as an example.
A survey by Positive Money found a widespread view among politicians
too that only governments can create money, with just one in 10 aware
that banks create most money in circulation (electronic money, not
cash).It is important to widen understanding, says Mr Dyson, because if regulators and policy makers are basing their views on the risks of another crisis occurring, or what might lead to one, on a model that shows banks will stabilise the economy, mistakes are likely.
Investors and money managers are also better equipped with a clear view of the unique ability of banks (and only banks) to create money by making loans, and how this can lead to instability. The problem is there are too few controls over how much they lend and for what purpose.
Nessun commento:
Posta un commento