...against fictions and other tall tales

Sunday, 17 January 2016

Stiglitz on credit creation by banks

For those who think that Joseph Stiglitz doesn't know that banks actually create credit:


"We are not in a corn economy where banks serve as an intermediary between farmers who have excess seed and farmers who want more seed. We are in an economy where banks actually create credit. And that makes a very big difference."

h/t: wonkmonk

7 comments:

  1. Thanks again Circuit.

    I presume from your caution that some people thought differently. That's why they're patzers and he's a grandmaster.

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  2. Does he believe in the money multiplier or the MMT view (loans create deposits):
    http://bilbo.economicoutlook.net/blog/?p=1623

    He likely follows the fractional reserve theory of banking, according to which banks can collectively create money (via the multiplier) but individual banks can't.

    At least that's how Stiglitz puts it in his macroeconomics textbook.

    However, the credit creation theory of banking is different: it holds that each individual bank can create money "out of nothing" by the simple act of extending credit.

    When banks make a loan they create a deposit and a loan. No prior cash needed. Banks have access to reserves when needed via the central bank.

    Firstly a bank creates a loan. So the loan is to person A, and firstly the deposit is to person A as well. At that point the bank is still fine and still fully funded.

    What happens then though is that person A wants to pay person B.

    If person B is at the same bank, then there is NO problem. The deposit is switched to person B and the bank is still fully funded.

    The fun starts when person B is at another bank.

    What has to happen that is that bank 2 has to take over the deposit in bank 1 from person A. That increases the assets of bank 2 which then creates a new deposit for person B.

    That’s how payment works. Somebody has to take the place of the original depositor in the source bank before you can create anything in the target bank.

    Of course at that point bank 2 is taking a risk on bank 1 and will expect to be paid by bank 1 an interest rate to compensate for that risk.

    And it also means that if bank 2 isn’t prepared to take a risk on bank 1, that nobody in bank 1 can pay anybody in bank 2.

    It’s this latter point that caused the creation of central banks – to make sure that the payment system clears. The theory being that all the banks trust the central bank ‘in the last resort’ and therefore the central bank can ensure payments always clear.

    So the cost of funding is really the payments bank make so they can be part of a payment clearing system.

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    Replies
    1. Very nice comment. Thanks for this, though I'm not as worried as you when economists teach the multiplier theory in their textbook. Most of them explain that it's not an ideal description. All models are "wrong" by definition. My favorite monetary economist, Ray Lombra, taught the simple multiplier theory in his textbook, pointing out the flaws. It's obvious he doesn't believe in it, but finds some merit in explaining it, and highlighting how the real world is more complex.

      In the sociology of organizations, textbooks all have a section on the "ideal bureaucracy", as proposed by Max Weber. No bureaucracy actually fits the description, but the concept provides a useful analytical tool to understand what distinguishes one organization from another. Check out Lombra.

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  3. Cdn Sectoral Balances15 July 2016 at 19:57

    How does one get in contact with you Circuit? No email I can find, and your last post was in Jan this year, but I'll try nonetheless. I really want to understand how you built your charts on Canada's sectoral balances you did a few years back. I'll provide an http link at the end of this comment.

    I'm not the best with navigating through CANSIM but I really want to understand how to recreate your graphs. Any help would be much appreciated, like with tables you used, and relevant identified rows/columns would go a long way. No one on the web has spelled out how this is calculated and your graphs seem the most in conformity with the likes of Stephanie Kelton's American sectoral balance graphs.

    Here's your article in question. Particulary graphs 2 and 3. Such amazing stuff, it's cathartic, but I need to know more, and I'm sure there's others like me.

    http://fictionalbarking.blogspot.ca/2011/05/right-way-to-balance-budget-target.html?m=1

    ReplyDelete
    Replies
    1. Thanks for your message. Feel free to write me an email at stlawrenceriver[at]hotmail.com

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