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How does the Fed move interest rates?
- Thread starter kmiklas
- Start date
there is known a limit to this based on reserve requirementsYes, of course. The main component of the Money supply is virtually always inside money created by fractional reserve bank loans.
Banks don't look at their reserves to see if they can make a loan. They borrow the money they need at wholesale rates and loan it out at retails rates. The loans they make are bank assets. They can borrow against them. Currently there is no fixed reserve requirement. Rather than controlling aggregate reserve balances, the Fed has joined the other advanced nations in using a different mechanism to control the funds rate.If the bank manager believes they may be short of needed reserves they will borrow from another bank at the overnight fed funds rate.there is known a limit to this based on reserve requirements
The only real limit to bank lending is demand. Of course the fed influences demand via its funds rate.
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Everything you mention after bullet points ... contradicts and points correctly to The Fed creating money.Banks, not the FED, are the ones that create money. We have 4 types of money in the financial system:
In a functional financial system, all forms of money are freely convertible with each other. When that conversion breaks down, serious problems arise in the financial system.
- 1-Cash: Issued by the United States Government, which is accessible worldwide and with a nominal size of $2 Trillion dollars.
- 2-Bank Deposits: Issued by commercial banks, with global access and with a nominal size of $16 Trillion dollars.
- 3-Central Bank Reserves: Issued by the Government, accessible only to commercial banks and with a nominal size of $3 trillion
- 4-Government Treasury: Issued by the United States Government, global access AND with a nominal size of $20 Trillion Dollars.
when the Federal Reserve buys $1 Trillion in US Treasury securities, it creates $1 Trillion in central bank reserves to pay for it. That happens whether the seller of the Treasury bonds is a commercial bank or a non-bank. If the Fed purchased a commercial bank's Treasury security, then the commercial bank's Treasury security asset is exchanged for central bank reserves.
If a corporation were to sell $1 billion in Treasury securities to the Fed, then the proceeds of the sale would be deposited with the commercial bank with which the corporation is registered. The Fed would add $1 billion in reserves to the commercial bank's Fed account, and the commercial bank would add $1 billion to the corporation's bank account. At the end of the transaction, the commercial bank would have $1 trillion in reserve assets from the central bank, balanced by an increase of $1 billion in bank deposit liabilities to the corporation.
Overnight lending is not real creation of money. Ok technically it is, but come let's be serious - that is only fiddling around the edges! Nothing like the trillions of long term credit (AKA money crack) to the economy/debt to The Fed created last 10-20 yearsBanks don't look at their reserves to see if they can make a loan. They borrow the money they need at wholesale rates and loan it out at retails rates. The loans they make are bank assets. They can borrow against them. Currently there is no fixed reserve requirement. Rather than controlling aggregate reserve balances, the Fed has joined the other advanced nations in using a different mechanism to control the funds rate.If the bank manager believes they may be short of needed reserves they will borrow from another bank at the overnight fed funds rate.
The only real limit to bank lending is demand. Of course the fed influences demand via its funds rate.
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2rosy commented: "there is known a limit to this [bank lending] based on reserve requirements" This not correct because banks that are solvent will always be able to meet their reserve requirement one way or another. I just used overnight lending on the intrabank funds market as an example of one of those ways. Currently, however, their is no Fed imposed fixed reserve requirement. I doubt 2rosy realized that. The main point here is that Demand for loans is what ultimately determines the money supply, because the money supply is dominated by "inside" money created when banks make loans...Overnight lending is not real creation of money. Ok technically it is, but come let's be serious - that is only fiddling around the edges! Nothing like the trillions of long term credit (AKA money crack) to the economy/debt to The Fed created last 10-20 years
in your world, can banks create an infinite amount of money?2rosy commented: "there is known a limit to this [bank lending] based on reserve requirements" This not correct because banks that are solvent will always be able to meet their reserve requirement one way or another. I just used overnight lending on the intrabank funds market as an example of one of those ways. Currently, however, their is no Fed imposed fixed reserve requirement. I doubt 2rosy realized that. The main point here is that Demand for loans is what ultimately determines the money supply, because the money supply is dominated by "inside" money created when banks make loans...
leonel's post is correct! Both the government AND private sector banks create money.(in response to a post by leonel) Everything you mention after bullet points ... contradicts and points correctly to The Fed creating money.
The money the government creates is "outside" money. It is created via deficit spending, and it gets into the private sector by being spent in. At any time, most of the outside money is present in the form of Treasury securities. Outside money remains permanently in the private sector until taxed away.*
The money banks create is "inside" money. Inside money is temporary money. It appears when a loan is made and it disappears when the loan is paid off.
The vast majority of the money supply in the private sector at any time is "inside money" ! The amount of inside money depends on demand for credit. Demand decreases as the amount of credit issued increases, but the functional form of this relationship is far from linear; thus the "credit and business cycle".
The amount of credit money in the economy usually dwarfs the amount of "outside" money created by the government via deficit spending, because most of outside money is present in the form of Treasuries which, although they are a form of money, are not a part of the "money supply."
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*This paragraph highlights a conflict between orthodox, Twentieth-Century economics and heterodox, modern money theory (MMT) economics. In orthodox economics, if the government desires to spend in deficit it will have to borrow from the private sector, thus no new money is created by deficits. In MMT economics, the government does not borrow to spend in deficit but instead creates new money. According to MMT economists, the latter is what the U.S. Government does when it spends in deficit.
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The obvious answer --- you should have thought of this --- is that Banks can not create an infinite amount of money because Demand is not infinite. And that's true in my world and in your world.in your world, can banks create an infinite amount of money?
The FED creates money by setting the cost of money (rates). Lower rates, more money. Higher ratesleonel's post is correct! Both the government AND private sector banks create money.
The money the government creates is "outside" money. It is created via deficit spending, and it gets into the private sector by being spent in. At any time, most of the outside money is present in the form of Treasury securities. Outside money remains permanently in the private sector until taxed away.*
The money banks create is "inside" money. Inside money is temporary money. It appears when a loan is made and it disappears when the loan is paid off.
The vast majority of the money supply in the private sector at any time is "inside money" ! The amount of inside money depends on demand for credit. Demand decreases as the amount of credit issued increases, but the functional form of this relationship is far from linear; thus the "credit and business cycle".
The amount of credit money in the economy usually dwarfs the amount of "outside" money created by the government via deficit spending, because most of outside money is present in the form of Treasuries which, although they are a form of money, are not a part of the "money supply."
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*This paragraph highlights a conflict between orthodox, Twentieth-Century economics and heterodox, modern money theory (MMT) economics. In orthodox economics, if the government desires to spend in deficit it will have to borrow from the private sector, thus no new money is created by deficits. In MMT economics, the government does not borrow to spend in deficit but instead creates new money. According to MMT economists, the latter is what the U.S. Government does when it spends in deficit.
The FED increases and decreases (mostly the later in modern times) the amount of money in circulation through the setting of interest rates. Lower rates, more money. Higher rates, less. Not rocket-science.leonel's post is correct! Both the government AND private sector banks create money.
The money the government creates is "outside" money. It is created via deficit spending, and it gets into the private sector by being spent in. At any time, most of the outside money is present in the form of Treasury securities. Outside money remains permanently in the private sector until taxed away.*
The money banks create is "inside" money. Inside money is temporary money. It appears when a loan is made and it disappears when the loan is paid off.
....
Plus QEeeeeeeeeeeeee's and the "magical" fractional banking system created by gubmint.
Private banks are just a mechanism that allows it all to happen.