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Modern Money
Creation
"It
is much more realistic to say that the banks 'create credit,' that is, that
they create deposits in their act of lending, than to say that they lend the
deposits that have been entrusted to them. And the reason for insisting on this
is that depositors should not be invested with the insignia of a role which
they do not play. The theory to which economists clung so tenaciously makes
them out to be savers when they neither save nor intend to do so; it attributes
to them an influence on the 'supply of credit' which they do not have. The theory of 'credit creation' not only recognizes
patent facts without obscuring them by artificial constructions; it also brings
out the peculiar mechanism of saving and investment ... Nevertheless, it proved
extraordinarily difficult for economists to recognize that bank loans and bank
investments do create deposits." − Joseph Alois Schumpeter (1954)
The above is from Schumpeter's History of Economic Analysis, published
in 1954. Let us now look at two earlier works: Henry Dunning Macleod's The Theory and Practice of Banking, published in 1855-6 in two
volumes, and Robert Harrison Howe's The
Evolution of Banking: A Study of the
Development of the Credit System, published in 1915. Both scholars go at
lengths to describe how modern banks create deposits by extending credit or
buying real and financial assets. Building on Macleod (1866 [1855-6]), one of
the most influential early proponents of the Credit Creation Theory (CCT) of banking, Howe (1915) defines modern banks as follows.
"Our
modern banks are Banks of Discount as distinguished from their predecessors,
the Banks of Deposit, and have given an enormous impetus to commerce. They have
been able to do this because they can and do create credit that circulates the
same as money and in a far more convenient, safe and economical form."
Ravn (2019) clarifies as follows.
"In
a nutshell, other financial, non-bank firms can lend alright, but they pay out.
Banks don’t. Credit that is entered into a firm’s Accounts Payable during
lending is, in a bank, never discharged, but is renamed Customer Deposits and
serve as the money supply, by virtue of this credit being transferable and
accepted in payment by other banks and their customers."
Although not accepted as a universal truth,
the CCT had remained the dominant theory of banking until the early 1930s when
the Fractional Reserve Theory (FRT), one of the early proponents of which was
Alfred Marshal (1888), had replaced the CCT as the dominant theory.
The FRT can be summarized as follows.
Some seed money comes to the banks, and the
banks multiply that seed money. The banks do this multiplication by keeping a
percentage of that money as reserves and
extending the rest as loans to the public, which ends up as deposits at some
other banks. The banks then keep doing this among themselves until there is no
money left to lend and, in the process, create additional deposits—that is,
additional money—whose sum is equal to the sum of the loans extended. For
example, if the reserve ratio the banks abide by is 10%, the banks multiply the
seed money by 10.
Therefore, the FRT can also be called the
Deposit Multiplication Theory (DMT) in which although each bank is a financial
intermediary, the banking system creates money collectively as described above.
Whether the DMT or the FRT, the theory had remained in the back burner until
the end of World War I, when it started to gain prominence. One of the most
influential proponents of the FRT was Phillips (1920), and there had been many
others. By the early 1930s, it became the dominant theory and had remained so
until the 1960s.
The theory that replaced the FRT as the
dominant theory is the Financial Intermediation Theory (FIT) of banking, one of
the early proponents of which was von Mises (1912). The FIT challenge to the
FRT started with the seminal paper of Gurley and Shaw (1955) in which they
argued against the view that “banks stand apart in their ability to create
loanable funds out of hand while other intermediaries in contrast are busy with
the modest brokerage function of transmitting loanable funds that are somehow
generated elsewhere.” Later, Gurley and Shaw (1960) argued that the
similarities between the monetary system and non-monetary intermediaries are
more important than the differences, and that, like other financial
intermediaries, banks and the banking system have to collect deposits and then
lend them out. Then came the support of Tobin (1963) after which the FIT became
the dominant theory and had remained so, at least, until the start of the Global Financial Crisis (GFC) in the summer of 2007.
While Werner (2014, 2016), and Jakab and
Kumhof (2015, 2019) give detailed historical accounts of the evolution of the
three banking theories, Werner (2014, 2016) also provides empirical tests
rejecting the FRT and FIT and showing that the CCT alone conforms to empirical
facts. An earlier empirical work rejecting the FRT is a Fed working paper in
which Carpenter and Demiralp (2010) demonstrate that the relationships implied
by the FRT do not exist in the data.
More recently, Ravn (2019) examined the three theories, and although he
did not dispute the validity of the CCT for the current banking and monetary
system, concluded that the FRT and FIT do not need to be condemned to the dust bin
of history because the money incarnations of each banking theory facilitate
their appropriate use in analysis of historical and future banking and monetary
systems and argued that although under current conditions individual banks can
and do indeed create money all on their own, one should not downplay the
enabling role that clearing plays in facilitating money creation, absorbing the
money created and concealing the origin of money in banks' credit creation.
A fourth theory which had remained at the
fringes until recently is the State Theory of Money—also known as chartalism
(the Latin word "charta" means ticket, token or paper)—formulated by George
F. Knapp (1973 [1905]). According to Knapp who coined the name chartalism,
money is "a creature of the state", and Rochon and Vernengo (2003)
argue that Knapp seems to suggest that this is because the State determines the
unit of account. Indeed, citing Knapp, Keynes (1930) also asserts that "the
age of chartalist or State money was reached when the State claimed the right
to declare what thing should answer as money to the current money of account—when
it claimed the right to enforce the dictionary but also to write the
dictionary", and that "[t]oday all civilized money is, beyond the
possibility of dispute, chartalist." Later, Abba Lerner (1947) brought to
the fore taxation as the main cause for the acceptability of money because
"before the tax collectors were strong enough to earn for the State the
title of creator of money, the best the State could do was tie its currency to
gold or silver," although neither Knapp nor Keynes made such a claim.
The Modern Monetary Theory (MMT) —also known
as neo-chartalism—recently popularized by the American politicians Bernard
Sanders and Alexandria Ocasio Cortez is a form of chartalism. Wray (2014)
describes the role chartalism plays in the MMT, and Lavoie (2014) provides a
friendly critique of neo-chartalism (also see Rochon and Vernengo 2003). According
to the MMT, money is injected into the system by the government as the monopoly
issuer of currency, and the banking sector leverages the government-injected
money, increasing the amount of money in circulation. While the MMT argues that
what is necessary for the existence of a monetary economy is the State power to
create money and to ensure its general acceptance by imposing taxes, many of
its critics object to the MMT emphasis on taxes and argue that what is
essential for the existence of a monetary economy is the State's ability to
enforce the civil law of contracts under which contracts are settled.
Although the origins of the MMT go back to
the early 1990s and debates on neo-chartalism have been going on for longer
than a decade, since many new supporters and opponents have jumped in the wagon
after the MMT became popular in the summer of 2018, the intensity of the
debates has been growing. The reader can consult, for example, the October 1,
2019 issue of the Real-world Economic Review for a recent debate.[i]
A detailed discussion of the MMT is
beyond the scope of this article. However, focusing only on the payment and
settlement aspects of the MMT, we mention that an important contribution of the
MMT is the clarification of the role the Treasury account at the Central Bank—the
Treasury General Account (TGA) in the US and the Treasury Single Account (TSA)
in most other countries (see, for example, Yaker and Pattanayak 2010)—plays in
the money creation process.
In the rest of this section, we give a brief
description of domestic money creation, which we will need in the next section.
In many jurisdictions, domestic banks can create foreign currency (mainly US
dollar and euro) deposits by extending foreign currency loans also, but we
leave this out for simplicity. Further, we avoid discussing the roles the
international monetary system, as well as shadow banks, play in modern money
creation also for the same reason.
Since we ignore the shadow banks and the rest
of the world for simplicity, there remain four major players in domestic money
creation: (1) the Treasury, (2) the Central Bank, (3) the banks, and (4) the non-bank
rest consisting of non-bank financial corporations, non-financial corporations,
and households. A fifth player is the banking regulator unless the Central Bank
is it, and there are many jurisdictions in which there are multiple banking regulators.
Irrespective of the case, however, it is always the Central Bank that sets the
reserve requirement as the reserve requirement is a monetary policy tool,
whereas the banking regulator sets the capital requirement (see, for example,
Öncü 2017 for a detailed discussion), among other things.
The three primary types of money in current domestic
monetary systems are (1) cash (banknotes and coins), (2) reserves (deposits of
the banks at the Central Bank), and (3) customer (non-bank rest) deposits at
the banks or, for short, deposits. Deposits are claims on the Treasury created
cash, as well as on the Central Bank created reserves. As empirically demonstrated by Werner (2014,
2016), only the CCT conforms to empirical facts, meaning banks create deposits
by extending loans and purchasing real or financial assets. Or, in Schumpeter's
words, "bank loans and bank investments do create deposits (Schumpeter
1954)."
However, as Carney (2013) pointed out, bank
"loans create a lot more than deposits," and we add that the same is
true also for bank investments, that is, bank purchases of real or financial
assets. Such transactions create two additional liabilities for banks, which
are regulatory: the capital requirement liability for the asset (loan or
investment), and the reserve requirement for the liability (deposit). And these
liabilities have to be met ex-post, not ex-ante as usually believed (see, for
example, "Reserve Computation and Maintenance Periods" section of the
"Reserve Maintenance Manual" of the Fed, for reserve requirement
liabilities)[ii],
meaning banks are not constrained by capital or reserve requirements but mainly
by "profitability and solvency considerations (Jakab and Kumhof
2015)."
To meet the capital requirement, banks can
sell shares, raise equity-like debt or retain earnings, and Carney (2013) gives
detailed examples of how banks can do these. We refer the reader to his article
for this. However, the Central Bank is the monopoly creator of the reserves,
meaning banks have to meet the reserve requirement by obtaining the reserves
from the Central Bank. There currently are a few countries, such as the UK and
Canada to name two, where there is no reserve requirement but banks need reserves
to settle accounts with other banks whether there is reserve requirement in the
country or not.
Under the current institutional arrangements,
the Central Bank can create reserves through:
1) the loans it makes from its so-called discount
window and, if exist, certain liquidity facilities to the banks and qualified
others;
2) the reverse repurchase agreement
transactions (so-called open market operations) with its counterparties to buy
Treasury and other securities it deems fit;
3) the purchases of Treasury securities (so-called
quantitative easing) and other financial securities it deems fit (so-called credit easing) in the secondary
market,
as these transactions
create new deposits in the accounts of banks at the Central Bank. If, on the
other hand, the Central Bank signs a repurchase rather than a reverse
repurchase agreement through open market operations, it creates reverse
repurchase liabilities, depleting some reserves. The reason is that in a repurchase agreement
one party pledges collateral to a counterparty to borrow funds with the promise
to purchase the collateral back at an agreed price on an agreed future date,
and while the agreement is a repurchase agreement from the point of the
borrower, it is a reverse repurchase agreement from the point of the lender.
Hence, the transformation of some reserves to reverse repurchase liabilities.
This is where the Treasury
comes in. The Treasury provides most of the collaterals acceptable to the
Central Bank through which the Central Bank creates most of the reserves.
Further, the Treasury maintains the account from which it makes its payments at
the Central Bank in all countries, although it may maintain accounts at some
designated commercial banks also (see Yaker and Pattanayak 2010). We should
mention that, leaving aside the questions of why and since when, the Central
Bank can currently lend to the Treasury or purchase securities from the
Treasury hardly in any country. The "central bank independence"
reigns supreme by law, although not necessarily in practice.
Other than banks and the
Treasury, there usually are a few other entities that are allowed to maintain
deposit accounts at the Central Bank in every country, not to mention foreign
central banks. All deposits other than bank deposits at the Central Bank,
including reverse repurchase liabilities, drain reserves if they go up. In
other words, all deposits other than bank deposits at the Central Bank should
be viewed as a fourth type of money, since changes in their balances impact
reserves, that is, base money, so that they should be managed in order not to
create liquidity problems in the domestic banking system (see, for example, Pozsar
2019).
We conclude this section
with the following observations.
1) When the Treasury sells
its bonds to the non-bank rest, there is no new money creation. Only existing
money changes hands, and if that money gets deposited in the TSA, equal amounts
of reserves and deposits get extinguished. Likewise when tax payments get
deposited in the TSA. But after the
Treasury spends the deposited amount, both base money and broad money come back to where they were
before, keeping everything else constant.
2) When the Treasury sells
its bonds to banks, three things may happen.
a) If there are banks at
which the Treasury can maintain deposit accounts with or without
restrictions, or there are no such banks and only those banks at which the
Treasury cannot maintain deposits accounts purchase the Treasury bonds, then
these banks buy the Treasury bonds by borrowing from the Central Bank against
which the Central Bank increases the balance of the TSA. After the Treasury
spends the balance, an equal amount of base and broad money get created.
b) If there are banks at which the Treasury
can maintain deposit accounts without restrictions and only those banks at
which the Treasury can maintain deposit accounts without restrictions purchase
the Treasury bonds, then new broad money gets created as usual. But since the
Treasury has to spend only from the TSA, the result is the same as above.
c) If there are banks at
which the Treasury can maintain deposit accounts with restrictions, then a
combination of the above two happens.
These observations mean that
whether the Treasury sells some amount of the bonds to banks or the same amount
directly to the Central Bank (or the Central Bank loans the same amount to the
Treasury), the changes in the base and broad money are the same after the
Treasury spends the amount, keeping everything else constant. The latter is, of
course, cheaper for the Treasury because the Central Bank has to pay a large
percentage of its profits to the Treasury in every country, whereas the banks,
generally, do not.
Ne güzel.
Halbuki o konu çok ayrıntı bir konu benim için.
Şöyle geçerken gözüme çarpmış bir konu.
Yazdığım uzun şeyleri kimse okumuyor, sanırım İngilizce olduklarından. Ukalılıktan değil, dünya okusun diye. Aşağıda öyle bir şey var. Bir makaleye bir bölüm olarak yazılmıştı ama oradan bir makale, hatta kitap, çıkar. Elinizde bulunsun.
