I agree with you and the Chartalists on the reserve impact due to QE – as you point out, as this is simple double entry book keeping, i.e. loan creates reserve.

However, I disagree with your statement “Does it matter that these reserve balances are so high? Not in the least”. The reason I disagree is that whilst bank reserve balances are high, this is largely because their clients have banked the proceeds of QE as deposits with them. So in reality it is the banks clients that feel “cash heavy”. Now whilst the total level of reserves remains unchanged this hides the fact that within this closed circuit we call money, markets are being bid up periodically by people/market participants feeling cash heavy, profit taken,new buyer, etc. You wrote a blog demystifying this yourself – people/markets are feeling cash heavy – hence the plethora of “crap” written in the mainstream media. Nonetheless, the Journalists are however expressing what I believe to be a wide spread “feeling”.

So – yes it does matter what level of reserves balances are in an economy.

I also think the Chartalists do not adopt a very practical resolution method. Essentially spend fiat money until full employment (as defined) is reached. Look at unemployment and fiscal deficits last year – conclusion very little money helped employment particularly the US, why? Govt spending was aimed at maintaining the status quo, supporting TBTF, propping up auto. The system needs to purge the mal-investment and excess leverage to grow – maintaining the status quo will only prolong the pain – ala Japan.

So yes in theory to huge fiscal spending too effectively fill the output gap (Keynesian thinking) – but the reality is govts particularly in the US spend on the highest paid donor = the existing elite = maintaining the status quo.

Also, I signed up to your blog the day before Melbourne Cup and the first email I got recommended Shocking – I put $10 on the nose at 10-1.

Best regards,

Gary

“My counter to that would be that in the UK and US where the economies remain extremely sluggish, there is very little risk of an inflation breakout”.

I agree to that, wholeheartedly. The last craze in the US now is that some people are actually calling for a decrease in the minimum wage, on the grounds that this is THE way to cut down unemployment, without triggering inflation. Believe it or not.

What’s more, I also believe this probably holds true to Australia. The latest figures in the “Australian National Accounts: National Income, Expenditure and Product”, released by the ABS don’t seem too bullish, to me.

If you are interested, have a look at Analysis and Comments (cat. 5206.0), 16 Sep 2009. Curiously, in spite of the news that employment had increased in November, in the September Quarter hours worked were still decreasing.

Have a look also at the charts for imports and exports.

As to the point about past surpluses not creating the same run up in reserve balances you are right. This is because, as I noted in the post and the comment above to Marco, there are two key drivers of reserve balances: government spending and government sector buying/selling of bonds. In the past when deficits were run in the US, the impact on reserve balances was neutralised by the issuance of government bonds. With the extensive quantitative easing program in place over the crisis, the government sector (considered broadly to include the Fed) has been a net buyer of securities, which pushes in the same direction on reserve balances as government spending. In fact, there is a good case to be made that the role of government debt is not to “fund” government spending, but simply to drain reserves. In any event, my argument is that reserve balances will not fall while governments are running deficits and buying bonds. On or other (or both) has to reverse for balances to decline once more.

While you have been careful in your comments to use the phrase “excess reserves”, in all but my third last paragraph I was talking about aggregate reserves not excess reserves. The notion of excess reserves is only relevant in the US where there is a minimum reserve requirement (i.e. not in the UK, the country discussed in the article linked to at the top). As I note in that paragraph, the dynamics of excess reserves are more complicated as they depend on the mix of funding sources of each bank. Nevertheless, it remains the case even for excess reserves that government interactions with banks (fiscal and monetary) are significant drivers of balances. It still doesn’t make much sense to talk about banks “hoarding” their excess reserves as it is the Fed’s quantitative easing that’s pushing the balances up not the lack of lending.

Firstly, in the case of excess reserves in the US this is largely due to the Fed now paying interest on reserves. Absent the Fed paying interest on reserves they would not be able to meet their monetary policy target of 0-0.25%. Banks would bid the rate down in the overnight market thus their rate targeting would be ineffective. Notice how excess reserves exploded once the Fed started paying interest on reserves.

Secondly, excess reserves will not go down until govt runs budget surpluses. The US has run a deficit for the most part of the last 25yrs??? Budget surpluses affect the monetary base but are not a driver of excess reserves.

The three main drivers of excess reserves are: Bank capitalization (ability) and desire to lend, consumer and business desire to lend/save or in the current environment hoard cash and finally Central banks rate targeting method.

Thanks for another great post Stubborn!

Let me see if I understand this point: every time the Executive Branch component of the Government Sector makes a transfer, it creates reserves (as in the tax refund example).

Clearly, as governments all over the world have made transfers due to the GFC and associated recession, then reserves worldwide must be large, regardless of how liberally or conservatively banks lend.

But, do these reserves have any economic implication? Because in general I suppose banks don’t pay interests on them (except when coming from interbanks or Central Bank loans).

Is the money supply according to the MMT equivalent to the sum of cheque deposits and cash?

As a side note, some time ago I found an Austrian website where it was argued that Central Banks INDUCED banking insolvency crisis.

They were arguing from the American experience (which in itself is quite curious, as the Fed was created AFTER the bank run of 1907, if I remember well) and assuming a fractional reserve system.

They presented a simplified example, very much like yours. Their point was that, when processing transactions involving two banks (like your second example), one bank could run short of money. And, of course, they, in the usual manner, invoked responsibility and accountability and all that BS that Central Banks supposedly encourages banks to violate.

As you explain here, it is the presence of the Central Bank that, in the last instance, guarantees that the transaction is done (if there is no possible interbank lending). Not like they claim. In other words: they confuse the remedy with the disease.

Besides, in many places there is a Depositors Guarantee: which I believe acts like a kind of insurance.