Nick Rowe didn’t love David Andolfatto’s post on excess reserves and inflation. Of course, being a Market Monetarist, his view is a bit different. He doesn’t like the idea that banks don’t “lend reserves” and instead argues that banks do indeed lend reserves for practical purposes. He says:
“We define “excess money” as the actual stock of money that people hold minus the stock of money they desire to hold (given prices, income, interest rates etc.).
If an individual person has excess money, he can and will get rid of it, by spending it or by lending it. (And “lending” means “buying an IOU from someone”, so it’s the same as spending.) But that just means another individual person now holds it.
Let’s cut to the goddamn chase: banks lend reserves.
And the fact that banks cannot in aggregate get rid of the excess reserves is a central part of the standard textbook story of why excess reserves raise the stock of money, which creates an excess supply of money, which raises the demand for goods and the prices of goods. If banks in aggregate could get rid of reserves by lending them, the excess reserves would have at most only a temporary effect.”
Monetarists like focusing on “money”. The problem is, they don’t define money all that well in their models and their focus on “money” leaves them missing the fact that there are many “money like” assets in a monetary economy. Defining one or even a few items as “money” and then building a model around these particular financial assets is a very narrow way of understanding the monetary system. And that appears to be what happens in the Market Monetarist model. And while there’s much to like in the Market Monetarist view I think this narrow perspective often leaves us missing important parts of the bigger picture.
In this case Nick is arguing that banks have “excess reserves” representing “excess money”. So they lend them to one another, which, in the aggregate accomplishes nothing since the banking system as a whole cannot get rid of their reserves. That’s a fine view and an accurate description as far as it pertains to banks. But it doesn’t really apply to the aggregate economy in the sense that Nick would like us to think.
When QE is implemented, the Fed buys financial assets and credits banks with reserves. If the transaction doesn’t involve a non-bank then this is a clean swap of a safe asset for a safe asset (for instance, a T-bond for reserves). The private sector’s net financial assets haven’t changed. So it’s a lot like having swapped a savings account for a checking account. Now, some people might say that once you lose the saving account and have a checking account then you have “excess money”. But who cares? No on in the real world thinks that way. They look at their financial assets and savings relative to their income and decide whether they can spend a certain amount of money. You don’t say “aww shucks, my CD just matured and now I have all this ‘excess money’ to spend.”
Nick is right that banks can end up with “excess money”. But the way I view it the entire reserve system is an excess to private competitive banks as it’s really the result of a regulatory overhaul that impedes their true desire to monopolize the entire system (in which case there would be no reserves at all as there would only be one bank in which to settle all payments). So talking about reserves as “excess” is misleading in the first place. And then applying it to some practical economic sense outside the banking system simply leads to the misguided view that the Fed can determine the amount of spending in the economy simply by changing the portfolio of assets held by the private sector. And it all ends up with a lot of confused views about “money”, banking and the economy.