...against fictions and other tall tales

Thursday, 10 November 2011

Bank reserves and credit creation

I agree with Joseph Laliberté, a French-speaking blogger out of Canada dedicated to MMT: there isn't much difference between Treasury bonds and commercial banks' reserves with the central bank. Other than the fact that one can be used as collateral, both share similar properties.

Also, more importantly, Laliberté makes a good observation when arguing that bank reserves aren't inherently inflationary. The reason for this is simple: in a modern banking system, contrary to what most students are taught in economics courses, the level of reserves held at commercial banks does not have a significant influence on the level of credit creation. This point was well described recently by economists Claudio Borio and Piti Disnyatat:
The amount of credit outstanding is determined by banks’ willingness to supply loans, based on perceived risk-return trade-offs, and by the demand for those loans. The aggregate availability of bank reserves does not constrain the expansion directly. The reason is simple...in order to avoid extreme volatility in the interest rate, central banks supply reserves as demanded by the system. From this perspective, a reserve requirement, depending on its remuneration, affects the cost of intermediation and that of loans, but does not constrain credit expansion quantitatively. [...]
By the same token...an expansion of reserves in excess of any requirement does not give banks more resources to expand lending. It only changes the composition of liquid assets of the banking system. Given the very high substitutability between bank reserves and other government assets held for liquidity purposes, the impact can be marginal at best. (2009:19) (original emphasis)
The point here is that lending decisions by banks are not based on the amount of reserves. Rather, bank lending depends in large part on whether banks can find a creditworthy borrower.


Borio, C and P. Disnyatat (2009): “Unconventional monetary policies: an appraisal” Bank for International Settlements Working Papers, No. 292.


  1. I can only commend the BIS for having excellent thinkers in their ranks, and commend you for promoting excellent and pragmatic scholarship.
    Well done

  2. I just saw your comment on the *heteconomist* designated post to Marc Lavoie's Friendly critique of MMT:


    It's a good exchange. It recaptures some topics that were discussed in FRB months ago on the need for underlying institutional structures.