So Much for my Agreements With Richard Koo….

Here’s some of the latest commentary via Richard Koo. ┬áSounds more alarmist than analyst to me…(via Warren Mosler):

“But nightmare scenario awaits when private loan demand recovers. The problem is what happens when private loan demand recovers. Loan books could grow more than tenfold in the US and five fold in Japan and Europe if bank reserves remain at current levels, triggering inflation rates of 500% to over 1,000%.

To avoid this outcome, central banks will have to mop up excessive reserves by raising the statutory reserve ratio, raising the interest rate paid on reserves, and selling government bonds. All of these measures will serve to lift interest rates, sending bond yields sharply higher and triggering a possible crash in the bond markets.

A sharp increase in government bond yields could lead to fiscal collapse in countries with a large national debt. For Japan, where the national debt amounts to 240% of GDP, the results would be catastrophic.

Expanding quantitative easing because it appears to be doing no harm is grievous error. Mr. Abe and his advisors may believe that all they have to do once their anti-deflationary policies succeed and JGB yields start to rise is have the BOJ buy more bonds. However, bank reserves under quantitative easing have risen to a level capable of fueling a 500% inflation rate, in which case the BOJ would have to sell, not buy, JGBs.”

Of course, banks don’t lend reserves so they don’t create the risk of the money supply exploding….Koo is still very much working from a neoclassical position despite the brilliance behind his understanding of the balance sheet recession.


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Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services.

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  1. Excess loan demand.We should be so lucky! Tell him to come to the UK and look at 1 in 10 commercial shops shut for lack of demand etc.Nowt like a theorist detached from reality to get the weekend off to a good start.

  2. Cullen, is it true that in a normal economy (not current Japan or US) with no balance sheet problems would a high level of excess reserves or big monetary base lead to more loans/credit, money, and thus inflation? I’m not necessarily saying that the excess reserves CAUSE that activity, but the presence of excess reserves can only be due to Central Bank monetary expansion (loosening).

    If I’m not mistaken in non-BSRecession economies there has been a decent correlation between inflation/bank money albeit with significant lag time. The only transmission mechanism I can think of that links excess reserves/monetary base to inflation is lower rates (since those excess reserves come from CBank expanding its balance sheet) and “central bank expectations” or optimism, both of which fuels credit growth.

    I’m just trying to understand if I understand your view of what excess reserves does

  3. That is the funny thing with economists, even if they get an aspect correct, they are almost sure to mess up on several others.

  4. It is staggering to read the sort of stuff (banks lend reserves) that economists labor under. And even more so when you consider the direct and indirect power and influence these people have. Someone should ask Koo what he thinks the inflation rate will explode to in Canada and Australia when loan books grow.

  5. beyond disappointing

    truly bizarre

    the strange combination of understanding sector financial balances in full, while not understanding bank reserves and banking – at all, apparently

  6. As your resident economic ignoramous, I’m still having trouble understanding an important point. You say that banks don’t loan reserves. But if a bank makes a loan in the form of a check, someone will eventually cash that check at that bank. The cash that the bank settles the check with comes from its vaults. That cash originally came from the the Federal Reserve Bank (as only they may print money). Why is not that cash considered a part of the bank’s reserves?

  7. Reserves are on the asset side of a bank’s balance sheet. Sure, if you take current reserves and the minimum reserve ratio you can draw the conclusion that banks could expand their balance sheets by multiples. But this is not the only constraint on them, you have the liability side too. Banks need to find funding for this expansion in their loan book (thru deposits, bond issues etc) and more importantly their capital ratios need to be met. And banks today might have lots of leeway to their minimum reserve levels but with higher capital requirements they have very limited ability to make lots of new loans. If a bank wants to expand its loan book tenfold, it is going to have to roughly expand deposits, bond issuance and equity tenfold….good luck with that…..

  8. Yes, banks are capital constrained which makes it even more ridiculous to claim that they might be able to expand the money supply in such a manner that might induce the kind of inflation Koo talks about….

  9. On what basis do banks have to hold excess reserves?

    Aren’t the so-called excess reserves only cash not invested elsewhere and so invested with the Central Bank?

    Why can’t they withdraw the excess reserves and lend the cash to the private sector?

    If the Fed wants to keep the money from the excess reserves from entering the private economy, doesn’t it have to sell securities back to the banks?

    How does the Fed make it attractive for the banks to buy the securities back from the Fed?

    Won’t the sale have to be profitable for the banks, otherwise they won’t participate if they can get better rates of return elsewhere?

    So the doesn’t the Fed have to sell the securities of longer duration before their market yield rises to above the yield at which they were sold by the banks to the Fed, otherwise the banks make a loss on sale which diminishes their profits/capital?

    Isn’t this part of how the banks get rescued, the Fed buys back the securities before rates rise so the banks get a capital profit?

    Alternatively the Fed has to constantly lead higher on interest rates so that the cash representing excess reserves stays on deposit at the Fed, but that would choke an emerging private recovery as well as preventing inflation.

    Alternatively the Fed has to require an amount of reserves for each bank nearly equal to the current total reserves to prevent the excess being withdrawn and lent, but banks will scream if they have to have huge reserves locked up at the Fed at lower than market rates.

    The only other solution I see is government austerity through taxes and spending cuts sucking money out of the private sector whenever credit starts to increase, thus reducing government demand and private discretionary spending and thereby containing inflation.