So, fractional reserve banking.

[Zippyjuan]

How do you explain such growth in credit then as monetary base remained relatively flat(pre 2008)?

What is in the monetary base? The monetary base is the amount of cash in the system combined with the amount of excess reserves banks keep with the Federal Reserve. If they aren't keeping lots of excess reserves (like they are now), the monetary base is lower. They currently have about $2 trillion in excess reserves. That is money not getting lent out. If they are making loans (such as during the housing bubble), they have fewer excess reserves and the monetary base is lower.

The Adjusted Monetary Base is the sum of currency (including coin) in circulation outside Federal Reserve Banks and the U.S. Treasury, plus deposits held by depository institutions at Federal Reserve Banks. These data are adjusted for the effects of changes in statutory reserve requirements on the quantity of base money held by depositories

http://research.stlouisfed.org/fred2/series/BASE/

 

[cubical]

What is in the monetary base? The monetary base is the amount of cash in the system combined with the amount of excess reserves banks keep with the Federal Reserve. If they aren't keeping lots of excess reserves (like they are now), the monetary base is lower. They currently have about $2 trillion in excess reserves. That is money not getting lent out. If they are making loans (such as during the housing bubble), they have fewer excess reserves and the monetary base is lower.

Total credit is over 50 trillion.

Now look at how little the monetary base has grown(up till 08) relative to credit.

If spending was really only limited to the monetary base, as you explain in your example, I find it hard to believe 50 trillion could exist in credit.

 

[TomtheTinker]

 

[cubical]

This is what I was speaking to about the banks getting the fed to cover any cash requests, as long as they had the loan as collateral on their books as one of their assets.

But it does not explain why 50 trillion in credit can exist on top of a 800 billion in monetary base. If the 9x rule was followed, it would mean total credit should peak at 7.2 trillion, but this is not even close. This could only happen if, in this example, the original 10 billion was withdrawn at the bank, and deposited elsewhere, creating a new 9x money creation. Or something along those lines.

 

[Zippyjuan]

The base is not a measure of bank deposits or lending potential- only excess deposits they chose not to lend out. It is also not a measure of money supply. The more they lend out (from those excess reserves), the smaller the monetary base gets because that lowers their excess reserves.

 

[cubical]

The base is not a measure of bank deposits or lending potential- only excess deposits they chose not to lend out. It is also not a measure of money supply. The more they lend out (from those excess reserves), the smaller the monetary base gets because that lowers their excess reserves.

Required reserves also count towards monetary base.

 

[Zippyjuan]

Correct. But the monetary base still does not necessarily reflect the amount of money available to the bank to lend out. They can also keep reserves in their own facilities to meet reserve requirements or to park excess reserves.

http://www.federalreserve.gov/monetarypolicy/reservereq.htm

Reserve requirements are the amount of funds that a depository institution must hold in reserve against specified deposit liabilities. Within limits specified by law, the Board of Governors has sole authority over changes in reserve requirements. Depository institutions must hold reserves in the form of vault cash or deposits with Federal Reserve Banks
.
The dollar amount of a depository institution's reserve requirement is determined by applying the reserve ratios specified in the Federal Reserve Board's Regulation D to an institution's reservable liabilities (see table of reserve requirements). Reservable liabilities consist of net transaction accounts, nonpersonal time deposits, and eurocurrency liabilities. Since December 27, 1990, nonpersonal time deposits and eurocurrency liabilities have had a reserve ratio of zero.

The reserve ratio on net transactions accounts depends on the amount of net transactions accounts at the depository institution. The Garn-St Germain Act of 1982 exempted the first $2 million of reservable liabilities from reserve requirements. This "exemption amount" is adjusted each year according to a formula specified by the act. The amount of net transaction accounts subject to a reserve requirement ratio of 3 percent was set under the Monetary Control Act of 1980 at $25 million. This "low-reserve tranche" is also adjusted each year (see table of low-reserve tranche amounts and exemption amounts since 1982). Net transaction accounts in excess of the low-reserve tranche are currently reservable at 10 percent.

Beginning October 2008, the Federal Reserve Banks will pay interest on required reserve balances and excess balances.

 

[cubical]

Correct. But the monetary base still does not necessarily reflect the amount of money available to the bank to lend out. They can also keep reserves in their own facilities to meet reserve requirements or to park excess reserves.

Are you saying the reserves in their own facilities are not part of the monetary base? That does not see right. Monetary base from Wiki:

Notes and coins (currency) in circulation (outside Federal Reserve Banks, and the vaults of depository institutions), Notes and coins (currency) in bank vaults, Federal Reserve Bank credit (minimum reserves and excess reserves)

So money held in vaults outside of the Fed still counts towards MB.

Imagine if the entire monetary base was require reserves(which isn't the case). The total credit outstanding would be 7.2 trillion(in 2008). Where does the extra 40+ tillion come from.

 

[Bohner]

Low inflation. There are basically three things which go into determining an interest rate. First is the desired rate of return the lender wants. They add on to that the expected rate of inflation during the time of the loan (so that the return is real- after inflation) and a premium based on the riskyness of the borrower (more likely to pay back the loan- lower premium). If the future inflation rate is uncertain, that adds the same as a higher rate of inflation would. Demand for money is factored in as well- if people aren't borrowing you may have to lower your rates to attract more customers. Inflation has been low so that has allowed interest rates to stay low.

We can kinda thank China for that- in two ways. First, all the cheap junk they sell us kept the price inflation rate low. Second, their demand for US Treasuries kept the prices for them higher and longer term interest rates (like those for mortgages) lower (Treasury note prices move inversely to the interest rates- higher prices due to higher demand means lower rates- and long term loans like mortgages tend to track longer term Treasury notes- mostly the fifteen year ones).

Again... Not possible. Especially for interest rates to remain low during recessions without printing money like crazy.

This pretty much sums it up.

 

[Zippyjuan]

Sums what up? The monetary base is not a measure of the money supply- if that is what you want to look at, M2 is the most commonly used measure. And for all the money the Fed has tried to put out there to cause price inflation, it has to be circulating. That means people earning or borrowing and spending it on goods and services. Prices rising becasue people are using more dollars to try to purchase goods. The POTENTIAL is out there due to the various Quantative Easing the Fed has done but it is not getting lent out and spent so far. That is known as velocity- and that is way down. It is also sometimes known as a money multiplier. If velocity picks up, prices likely will as well and as prices rise, interest rates will rise as well (that iflation portion of interest rates I mentioned earlier). The faster money moves through the system or the more often it changes hands, the greater the pressure on price inflation.

Velocity is a ratio of nominal GDP to a measure of the money supply. It can be thought of as the rate of turnover in the money supply--that is, the number of times one dollar is used to purchase final goods and services included in GDP.

http://research.stlouisfed.org/fred2/series/M2V?cid=32242

 

[Bohner]

Sums what up? The monetary base is not a measure of the money supply. If that is what you want to look at, M2 is the most commonly used measure. And for all the money the Fed has tried to put out there to cause price iflation, it has to be circulating. That means people earning or borrowing and spending it. Prices rising becasue people are using more dollars to try to purchase goods. The POTENTIAL is out there due to the various Quantative Easing the Fed has done but it is not getting lent out and spent. That is known as velocity- and that is way down. It is also sometimes known as a money multiplier. If velocity picks up, prices likely will as well and as prices rise, interest rates will rise as well (that iflation portion of interest rates I mentioned earlier). The faster money moves through the system or the more often it changes hands, the greater the pressure on price inflation.


http://research.stlouisfed.org/fred2/series/M2V?cid=32242

Doesn't matter. Any money the fed loans to the bank is added to the monetary base. It doesn't necessarily lead to an increase in M2, much less it's velocity.

But yes, throughout the past 20 years, the fed has kept interest rates low by lending the bands money. Hence the increase in the monetary base.

 

[Zippyjuan]

Yes, it does matter as far as price inflation goes. You are right that it does't necessarily change M2 or the velocity. The market determines velocity- consumer activity. If a bank borrows money from the Fed and turns around and lends it out it will not effect the Base but if they kept it as reserves it would be added to the base. But unless their books were out of balance why would they borrow and keep it? Pay the fees and put up the collateral for the loan?

Let's look at how much money the Fed has been lending to the banks over time. We can check that as well. That would be through the Discount Window. Other than the spike during the bailouts (AIG was a huge chunk of it), it has been pretty much zero so they haven't been lending tons of money to the banks over the past 20 years.
http://research.stlouisfed.org/fred2/series/DISCBORR

 

[Zippyjuan]

So lets go back to the original premise of low inflation the biggest reason for low interest rates. One simple chart will show us. The red line is the US inflation rate, the blue line is the interest rate the Fed sets. Nice how they all move together pretty well.

http://wehrintheworld.blogspot.com/2009/07/inflation-and-interest-rates-since-1970.html

Compare that also with mortgage rates chart and you see the exact same thing:

http://inflation.us/charts.html

 

[Bohner]

So lets go back to the original premise of low inflation the biggest reason for low interest rates. One simple chart will show us. The red line is the US inflation rate, the blue line is the interest rate the Fed sets. Nice how they all move together pretty well.

http://wehrintheworld.blogspot.com/2009/07/inflation-and-interest-rates-since-1970.html

Compare that also with mortgage rates chart and you see the exact same thing:

http://inflation.us/charts.html

In some industries where bubbles end up becoming formed, prices rose WAY faster than the CPI. The CPI did a piss poor job of detecting that and the low interest rates allowed the bubble to grow much bigger than they would have under a free market monetary system. Those interest rates were far from natural.

 

[Zippyjuan]

In some industries where bubbles end up becoming formed, prices rose WAY faster than the CPI. The CPI did a piss poor job of detecting that and the low interest rates allowed the bubble to grow much bigger than they would have under a free market monetary system. Those interest rates were far from natural.

There are always some prices rising faster or slower than others or the CPI. The CPI measures prices- it does not predict them. It weighs the prices based on what percent of they average person's income gets spent on that item. If the average person spends 10% of their income on food, changes in the prices of food count as ten percent of the total CPI figure.

Bubbles constantly form and pop- some quietly, some with a bang. That says nothing about if interest rates were "natural" or not. If they are not "natural" what should interest rates be and why?

 

[matt0611]

I recently heard JEGriffin mention that fractional reserve banking works this way:

Assuming 10% reserves required by banks: I deposit $100, so the bank can now lend out up $900

I remember thinking myself that 10% reserves meant that if I deposited $100, the bank could loan up to $90 of that $100, leaving $10 reserves.

To me these are very different, the first example being inflationary, the second one not (I think).

Which one is correct? I figure JEG is correct, but just thought I'd ask.

They're both correct in a sense.

Because that $90 can potentially get into the banking system and then that bank can lend out 90% of that etc

If you keep going it adds up to a total amount of $1000 in the M1 money supply out of the $100 base money.

 

[Bohner]

There are always some prices rising faster or slower than others or the CPI. The CPI measures prices- it does not predict them. It weighs the prices based on what percent of they average person's income gets spent on that item. If the average person spends 10% of their income on food, changes in the prices of food count as ten percent of the total CPI figure.

Bubbles constantly form and pop- some quietly, some with a bang. That says nothing about if interest rates were "natural" or not. If they are not "natural" what should interest rates be and why?

I kind of agree with this guy on the issue...

 

[cubical]

So lets go back to the original premise of low inflation the biggest reason for low interest rates. One simple chart will show us. The red line is the US inflation rate, the blue line is the interest rate the Fed sets. Nice how they all move together pretty well.

http://wehrintheworld.blogspot.com/2009/07/inflation-and-interest-rates-since-1970.html

Compare that also with mortgage rates chart and you see the exact same thing:

http://inflation.us/charts.html

Or you can look at the real inflation rate. When new money enters the system through the purchasing of debt, of course rates will go lower(at least for a time).

 

[FindLiberty]

A Mandrake headache is 9 times worse than a migraine headache.

http://www.freerepublic.com/focus/f-news/888963/posts

 

[pmbug]

There are always some prices rising faster or slower than others or the CPI. The CPI measures prices- it does not predict them. It weighs the prices based on what percent of they average person's income gets spent on that item. If the average person spends 10% of their income on food, changes in the prices of food count as ten percent of the total CPI figure. ...

Are you suggesting the CPI is not manipulated for political (or centrally planned economic) reasons?

...
In a letter sent to the White House, Republican leaders outlined a plan that they said would provide $2.2 trillion in deficit reduction over the next decade. On top of the $800 billion in new revenue from a tax code overhaul, Republicans estimated they could save $300 billion by cutting discretionary spending, $600 billion in "health savings," $200 billion in changes to the consumer price index and another $300 billion in mandatory spending.
...

http://news.yahoo.com/blogs/ticket/...l-fiscal-cliff-talks-204652663--election.html