I am re-reading my college economics textbook (Principles of Macroeconomics by Mankiw). (I know he's a New Keynesian, but I'm going to read Economics for Real People after to get the Austrian background.) Mankiw talks about the market for loanable funds in which there is a downward sloping demand curve and an upward sloping supply curve. He gives an example of a tax reduction on interest and dividends as something that would shift the supply curve to the right, increase the quantity of money lent, and decrease interest rates. The idea is that if the effective rate of return on saving increases, then households will consume less and save more. What I don't get is how the supply of loanable funds increases just because people shift consumption into saving. If I have $50 and I put it into my bank account instead of spending it on a new baseball bat, that is supposed to increase the supply of loanable funds. But even if I spend it on the baseball bat after all, won't the money go into the bank account of the store I bought the bat from? Either way, doens't the $50 end up in someone's bank account? What is the net difference in the supply of loanable funds?
I just thought I would point out that Economics for Real People is a good book, but, as the name suggests, the target is the common Joe. You'll get disapointed if you expect to find nearly that kind of detail.
Equality before the law and material equality are not only different but are in conflict with each other; and we can achieve either one or the other, but not both at the same time. -- F. A. Hayek in The Constitution of Liberty
That sounds like complete nonsense to me.
The amount of money available for loans is completely uncorrelated with customer bank deposits. The Federal Reserve will create as much money as necessary, via monetizing the debt. If there's a "shortage" of cash (i.e., the Fed Funds Rate is rising), then the Federal Reserve will purchase debt and create more cash. The Federal Reserve may print as much money as it pleases via purchasing debt; the Federal Reserve has (literally) an infinite budget.
If you put money in a checking account, you're earning a negative inflation adjusted return. Inflation really is 7%-30% (depending on what measure you use), but you only get credited 1%-2% on your checking account. People saving money "stimulates the economy", because savers are letting the financial industry steal their wealth.
If you put your wages in a checking account, that means you worked in exchange for (literally) nothing. Over time, your savings will be eroded by inflation.
I have my own blog at FSK's Guide to Reality. Let me know if you like it.
vp3434: I am re-reading my college economics textbook (Principles of Macroeconomics by Mankiw). (I know he's a New Keynesian, but I'm going to read Economics for Real People after to get the Austrian background.) Mankiw talks about the market for loanable funds in which there is a downward sloping demand curve and an upward sloping supply curve. He gives an example of a tax reduction on interest and dividends as something that would shift the supply curve to the right, increase the quantity of money lent, and decrease interest rates. The idea is that if the effective rate of return on saving increases, then households will consume less and save more. What I don't get is how the supply of loanable funds increases just because people shift consumption into saving. If I have $50 and I put it into my bank account instead of spending it on a new baseball bat, that is supposed to increase the supply of loanable funds. But even if I spend it on the baseball bat after all, won't the money go into the bank account of the store I bought the bat from? Either way, doens't the $50 end up in someone's bank account? What is the net difference in the supply of loanable funds?
I think that's a good question. I'm not sure of what is the correct answer, but I'll try this:
1) The money used for consumption isn't necessarily kept in demand deposits, it can be withdraw as cash too, which prevent that money to be loaned out by banks.
2) Keeping money in demand deposits causes higher reserves to be kept by banks, as opposed to time deposits (savings account).
3) There's a timing factor that when new deposits are made into bank B that were withdrawn from bank A, it will take some time to be effectively loaned out.
But otherwise, because of the current fractional reserve banking system, demand deposits are effectively loaned out and contribute to the credit inflation and lowering of the interest rate.
There is no contradiction, because saving and lending is infact the same thing. When you put money into a bank account, what you are doing is lending your money to the bank. Your money is not saved in some vault with your name on it or anything, its lent out to whoever is willing to pay the interest rate for borrowing the money. This is fractional reserve banking. I know its got a bad reputation, but its a wonderful free market invetion. It makes it possible to connect short time lenders with long time borrowers. Statistically a large number of short time lenders, as a whole, act as one long time lender. As long as the borrowers are of high quality, all those lenders will get their deposits back on request. As long as the bank is able to pay back the deposits on request it has not broken any contract.
Cheers
In a market economy, saving does not increase the supply of loanable funds. Saving increases the demand for capital goods, since saving is needed to pay for capital goods in the first place. However, the supply of loanable funds is effected by indirect investment, or certificates of deposit. When time preferences become lower, it means that investment and saving rise simultaneously. As such, more people invest in CDs, raising the supply of loanable funds, which lowers the interest rate. This helps the economy lengthen the production structure.
The reason why monetary expansion is bad is because it messes with the interest rate temporarily by increasing the supply of loanable funds without an increase in saving/investment. This causes incorrect market signals which lengthens the production structure. What's wrong with this picture is that when monetary expansion ceases and the real interest rate rises, the demand for capital goods plummets because the increase in loanable funds was not sustainable and only the action of a central bank not individual saving and investment.
"There is only one innate right, freedom (independence from being constrained by another's choice), insofar as it can coexist with the freedom of every other in accordance with a universal law." - Immanuel Kant
DriftWood:There is no contradiction, because saving and lending is infact the same thing. When you put money into a bank account, what you are doing is lending your money to the bank. Your money is not saved in some vault with your name on it or anything, its lent out to whoever is willing to pay the interest rate for borrowing the money. This is fractional reserve banking. I know its got a bad reputation, but its a wonderful free market invetion. It makes it possible to connect short time lenders with long time borrowers. Statistically a large number of short time lenders, as a whole, act as one long time lender. As long as the borrowers are of high quality, all those lenders will get their deposits back on request. As long as the bank is able to pay back the deposits on request it has not broken any contract.
errrrrrrr, wrong. Putting your money in a bank in an irregual deposit means that you demand that money be returned to you at any time. So if the bank loans out that money and you demand it back before that money is returned, the bank is forced to fail and close down. The only reason this is possible today is because the Fed provides a larger supply of money so as many banks won't fail (and thereby fueling fractional reserve banking).
What you're talking about is a mutuum contract, which today is known as a certificate of deposit. This is when an individual lends money to the bank which is then loaned out for a higher interest rate. This is different since the original lender cannot withdraw any of his money at any time, which prevents the creation of new money.
Of course, in our modern government-controlled banking industry fractional reserve banking means that saving and an increase of loanable funds goes hand in hand. This is a bad thing though since it fuels never ending high monetary expansion.
Nope, I know what you are saying, i just dont agree.
Lets take the usual (irregular) deposit account, the contract is that the bank will return the deposited money on request (and pay a bit of interest). Nothing else, there is no mention in the contract what the bank may do with the money in the meantime. There is no mention that the bank has to keep the money in a vault, or wether it may invest it or lend it out. As long as the depositor gets his money back on request, no contract has been broken and no trust has been violated.
You are saying that without fractional reserve banking the bank could not keep its contract, and you are right. But fractional reserve banking would work even without a govt or a expanding money supply. There is lots of confusion out here about what fractional reseve banking is. All that fractional reserve banking is, is lending out deposit money (that has to be redemed on request), to long term borrowers. It works because all those borrower pay enough mortage payments, to cover the requests for money withdrawl that the depositors make. Sure, its a fine balance to get right. But that its the banks problem, if it breaks any conbtract it will get sued. Banks are pretty good at this balancing act, as most big banks have been around a hundred years. This system would work even under a gold coin system, it does not rely on increasing money supply.
DriftWood:All that fractional reserve banking is, is lending out deposit money (that has to be redemed on request), to long term borrowers.
And how does that not expand the money supply?
If I have a legal claim to $100 dollars sitting in the bank and they loan it out to someone else while I still have a 'redemed on request' claim on this money then where did the extra money that they loaned come from if not from expanding the money supply? Two different people have a legal claim on the exact same thing at the exact same point in time yet this is OK for some reason because they manage to balance (with the help of the Fed backed banking cartel) the amount of money coming in with the amount going out and if things get out of hand there's always the Fed to bail them out or if things get really bad the taxpayers.
That's an understatement because a few different people have a legal claim for the exact same good under 10% reserve banking and there's no possible way that all of these claims could be satisified at once.
I agree that there is a lot of confusion about fractional reserve banking but most of it stems from the fact that printing fake warehouse receipts to a fungible good is fraud...or the opinion that it isn't against bailment laws because 'there is no mention in the contract what the bank may do with the money in the meantime.'
How is money different than any other good that the warehouse can have complete control (with the added bonus of not being liable for losses incurred while this money is in their hands) while the manager of a grain silo would be liable for both fraud and losses if they practiced the same policies as banks?
DriftWood:This system would work even under a gold coin system, it does not rely on increasing money supply.
You may have noticed that we aren't on a gold coin system for precisely the reason that if there is an actual commodity backing the money supply there is a limit to the amount on expanding they can do.
Also haven't been any real bank runs since we went off the gold standard for this reason, what are you going to withdrawal but a bunch of worthless pieces of paper instead of a real good that can't be effectively counterfeited so you don't have to 'run' to the bank to make sure you get your money before the bank closes its doors because it can't fulfill its contractual obligations to *all* its customers.
Especially under 'a gold coin system' is it apparent that fractional reserve banking expands the money supply because the only other option is to get out a pick and shovel and dig up some more gold. I really can't believe you would suggest otherwise.
"And how does that not expand the money supply? [...] If I have a legal claim to $100 dollars sitting in the bank and they loan it out to someone else while I still have a 'redemed on request' claim on this money then where did the extra money that they loaned come from if not from expanding the money supply? Two different people have a legal claim on the exact same thing."
You have to remember that this other person that spent your money is now in debt to you. He will pay you back the full amount, and then some (interest). So when he spends your money, your no longer have any money in the bank. What you are left with is a note that says "Hi. I noticed you where not using your money, so I took it and spent it. Dont worry though, I'll give you back the money, and a little for your trouble whenever you want". Ofcourse, that is a simplification.. what really is going on is that all the depositors money is put into the same pool of money, the overall money in the pool stays much the same.. sometimes one depositors take out all their money, but they dont all do it at the same time.. which means that there always is lots of money in the pool gathering dust. So what they do is let borrowers, borrow money from that pool. When the borrowers make mortage payments, they put money back into the pool.. eventually every borrower will have put back all the money they borrowed into the pool and then some (interest). You see? There is always enough money in the pool to cover the random withdrawl request by depositors.
Dont get confused though, no money is created here. Its just a creative and innovative way of lending money. Both lenders and borrowers preferr this way of lending as it is less restrictive, more efficient and therefore cheaper. Imagine if you had $100 you wanted to lend out. Would you rather lend it out signing a contract that read "you will get back your money this time next year, and you will make one years worth of interst." Or would you rather sign a contract that read "you will get back your money whenever you want it, and you will get paid interest depending on however long your money was lent out". You see, the second contract is much better for you. You can decide that you want back your lent out money at any time. This is what happens with your money when you keep it with a bank. All your life savings have been lent out to other people, who have spent it already. However this does not matter as all the borrowers of the bank are paying back their loand to the bank on a regular basis. There are so many of them, that the bank always has enough money in its vaults to pay you back your money whenever you needed it.
But what about bank runs? What happens if all depositors requested their money back at the same time. This is rare, but sound banks have nothing to fear. They can always raise money by selling assets. What assets does a bank have? Its got lots of those borrowers that keep paying back mortages every month. Thats a bond that pays x percent of interest a year. It can sell that on the open market and raise money. It could seel all its mortage backed bonds, and if the bank had not undervalued the price of risk involved with its borrowers, then it could raise enough money to pay back all the depositors at once. A bank only has to fear a bank run if it prices risk incorrectly, that is if it loans out money to risky borrowers at a low interest rate.
You see? This system would work just fine even under a gold coins system. Its just another way to lend out money, no money is created in the process.
Why is it people pop into here and assume we're a bunch of idiots and just need a little voodoo economic theory to see the light?
What is this you're promoting here, some variation on the Real Bills Doctrine?
DriftWood:You have to remember that this other person that spent your money is now in debt to you. He will pay you back the full amount, and then some (interest). So when he spends your money, your no longer have any money in the bank.
Then this wouldn't be a 'demand deposit' now would it.
If one were to put their money into something like a CD then your theory would be true, the assumption is that the bank has full control of your money for the duration of the deposit, but the problem comes from them doing this for checkable deposits as well. Here your theory completely falls apart since through the magic of fractional reserve banking seven other people also have a legal claim to your deposited money as the base of this inverted pyramid.
I see you completely skipped over the question about bailment law and the morality of this whole system though. Little surprise there since everyone knows that fractional reserve banking by its very nature creates money in the process of its day to day workings.
Don't even start in on the little semantics game of saying credit isn't 'money' either, just for the sake of simplicity we'll say 'money and money substitutes' equals 'money' to make typing a little easier, ok?
DriftWood:You see? This system would work just fine even under a gold coins system. Its just another way to lend out money, no money is created in the process.
You keep saying that but give no proof to back it up other than a fallacious description of the inner workings of the banking system. Why don't you demonstrate how this would work through an example or something...maybe a description of how the bank's asset and liability accounts would change as a result of a person depositing money and the bank loaning it out to one of their customers who then spends it.
I would do this myself but all you need to do is search the forum archives to find an example I posted earlier that demonstrates the exact opposite of what you're claiming here. And I'm too lazy to do it again...