#money_banking/fed --- # Notes --- --- # Publication [Bank Reserves Dollars at Fed & Money Dollars at Banks.docx] Broke link. Bank Reserves Dollars at Fed & Money Dollars at Banks # Reserves Dollars & Money Dollars - Redux # Notes Published article by this name 6/13/2024 --- # References Refer to previous publication:[[Reserves Are Not Money]] Fed Funds trading only occurs between banks. It doesn’t entail money dollars. --- ## Backlink ```dataview Table Status, type as "Type" from [[]] and !outgoing([[]]) sort file.name asc ``` # Bank Reserves Dollars at Fed & Money Dollars at Banks Posted on Journal:[Bank Reserves Dollars at Fed & Money Dollars at Banks](https://freemarketcenterjournal.com/2024/05/16/bank-reserves-dollars-at-fed-money-dollars-at-banks/) # Notes Explanation of how **dollars held as reserves** cannot also act as money, and do not expand money supply. (Include this with the article on Bank Reserves and Money Creation.)(?) For example, when the country used gold as money, a person deposited gold in a bank in exchange for a banknote, and the gold no longer played the role of money. Only the banknote that represented a claim on that gold played the role of money while that claim was outstanding. This principle helps a person understand why the Federal Reserve system, which only creates reserves, cannot also create money. --- # Publication Bank Reserves Dollars at Fed & Money Dollars at Banks.docx - Doc >I have decided to republish this article in two parts. Part 1 reserve requirements and money creation. Part 2 explaining asset purchases based on money creation. Reserves Dollars & Money Dollars - Part 1 Reserves Dollars & Money Dollars - Part 2 # Bank Reserves Dollars at Federal Reserve & Money Dollars at Banks In my preceding article (Reserves Are Not Money), I described why “dollars” cannot act as bank reserves and bank “deposits” at the same time. I based that publication on a 100% reserve requirement in which, although money can be transferred from one bank to the other, banks cannot create new money. In this article, I will discuss the money creation process. # Introduction I, again, want to make my meaning of “money” explicit. "Money" consists of any economic good, or any claim on such a good, that serves as a general medium of indirect exchange and that acts as a final means of payment. Many people do not seem to understand that use defines money. “Moneyness” does not exist in any good or claim on such a good. That applies to dollars in any form. Dollars held as reserves cannot simultaneously act as money. This means that an increase in the number of dollars held as reserves, whether in the bank vault or at the Federal Reserve, does not simultaneously increase the quantity of “money.” I will describe how the reserve requirement regulates the number of money dollars (M-dollars) banks may create and how banks increase the number of money dollars in response to changes in total reserves. I will discuss reserve requirements and money creation by banks under five different scenarios: ü  100% Reserve Requirement ü  50% Reserve Requirement ü  10% Reserve Requirement ü  10% Reserve Requirement & Quantitative Easing (QE) ü  0.0% Reserve Requirement Since this discussion refers to money creation, I will refer only to “demand deposits”( aka transaction accounts.) ## Fractional Reserves Under a fractional reserve banking system, like the one that we have in this country, banks can create new money based on the percentage of reserve dollars (R-dollars) the Federal Reserve bank requires banks to keep on deposit at The Fed. If, for example, the Fed sets the reserve requirement at 50%, banks can create twice as many M-dollars as it has in R-dollars in its account at the Federal Reserve. This relationship should become clearer to you as you read on. ## Bank Reserves Model I will use the following model to describe the relationship between reserve dollars (R-dollars) and money dollars (M dollars) under the reserve requirements referred to in the five scenarios listed above. You will see that I move the fulcrum on this model to indicate the reserve requirements. As the fulcrum moves to the right, the reserve requirement declines, and the amount of money dollars (M-dollars) a bank may create increases. ## Money Creation and Reserves Model The following model shows the money-making potential of banks based on reserve requirements and actual reserves. In this case, the fulcrum remains in the middle because a bank’s books must balance, indicating the relative amount of money banks can create under one of the five reserve requirements scenarios. Having more bank reserves does not mean the banks will automatically create more M-dollars. They will only create more M-dollars if they find suitable assets to buy. # 100% Reserve Requirement I want to reiterate that _dollars_ cannot be reserves and money simultaneously. I discussed the scenario of the 100% reserve requirement in my previous article, but I will show it again here for your reference. ## Reserves Balance If the reserve requirement were 100%, banks could not create additional money. They would be restricted to facilitating market transactions and could not purchase assets based on the amount of demand deposit liabilities. _The following graphic shows the relationship between the quantity of bank reserves (R-dollars) and the quantity of money dollars (M-dollars) the bank could create based on the quantity of bank reserves (R-dollars) and the required reserve ratio. In the case of 100% reserves the quantity of R-dollars and M-dollars must match.)_ ![[Bank_Reserves 11.png]] ## Bank Account Balances As you might expect, bank deposit liabilities would equal the number of reserve dollars. In this scenario, the only asset the bank will hold will be its reserves at the Federal Reserve Bank. _The following graphic shows the relationship between the quantity of bank reserves (R-dollars) and the quantity of money dollars (M-dollars) the bank could create based on the quantity of bank reserves (R-dollars) and the required reserve ratio._ _In the case of 100% reserves the quantity of R-dollars and M-dollars must match.__.)_ ![[Bank_Balance_Sheet 11.png]] # 50% Reserve Requirement ## Reserves Balance If the bank reserve requirements were set at 50%, banks would have the capacity to create two money dollars (M dollars) for every reserve dollar (R dollar) they have, whether in their vaults or maintained at the Federal Reserve. _(The following graphic shows the relationship between the quantity of bank reserves (R-dollars) and the quantity of money dollars (M-dollars) the bank could create based on the quantity of bank reserves (R-dollars) and the required reserve ratio. The bank has no obligation to create as many M-dollars as they may have authorization to create.)_ ![[Bank_Reserves 21.png]] ## Bank Account Balances With a 50% reserve requirement, banks could create an additional M-dollar with which they could buy additional assets. Those assets would be recorded at the price paid by the bank and would normally consist of debt instruments from public or private entities. _(The following graphic shows quantity of M-dollars the bank creates and the total asset ==held by the bank== (R-dollars plus notes and securities purchased). The bank has no obligation to create as many M-dollars as they may have authorization to create.)_ ![[Bank_Balance_Sheet 21.png]] # 10% Reserve Requirement ## Reserves Balance If the reserve requirement were lowered to 10% (the level at which it was set for several years), the bank could create 10 M-dollars for every one R-dollar. You can see that the money-creation potential of a bank is increased tremendously when the reserve requirement drops to 10%. _(The following graphic shows the relationship between the quantity of bank reserves (R-dollars) and the quantity of money dollars (M-dollars) the bank could create based on the quantity of bank reserves (R-dollars) and the required reserve ratio. The bank has no obligation to create as many M-dollars as they may have authorization to create.)_ ![[Bank_Reserves 31.png]] ## Bank Account Balances With a 10% reserve requirement, for every $10 they created, banks could pay an additional 9 M-dollars for other suitable assets. _(The following graphic shows quantity of M-dollars the bank creates and the total asset ==held by the bank== (R-dollars plus notes and securities purchased). The bank has no obligation to create as many M-dollars as they may have authorization to create.)_ ![[Bank_Balance_Sheet 31.png]] # 10% Reserve Requirement & Quantitative Easing (QE) ## Reserves Balance During the financial crisis of 2008, the Federal Reserve, through its open market operations, created reserve dollars (R-dollars) far in excess of the 10% reserve requirement in effect at that time. They increased these reserves by purchasing assets from banks, which replaced some lower-quality assets with R-dollar reserves. _(The following graphic shows the relationship between the quantity of bank reserves (R-dollars) and the quantity of money dollars (M-dollars) the bank could create based on the quantity of bank reserves (R-dollars) and the required reserve ratio. The bank has no obligation to create as many M-dollars as they may have authorization to create.)_ ![[Bank_Reserves 41.png]] ## Bank Account Balances After QE Hypothetically, after this increase in bank reserves, banks could have increased the level of their assets manifold. That did not happen. _(The following graphic shows quantity of M-dollars the bank creates and the total asset ==held by the bank== (R-dollars plus notes and securities purchased). The bank has no obligation to create as many M-dollars as they may have authorization to create. In the case of QE banks did not create more M-dollars or buy more assets.)_ ![[Bank_Balance_Sheet 41.png]] ## Monetary Expansion during QE Many people expected that this would cause a large spike in the quantity of money (M-dollars.) Despite the increased capability of banks to create money dollars (M-dollars) because of the expansion in bank reserves (R-dollars), this did not occur. The total assets for banks remained essentially the same; only the composition changed. Now, instead of notes and bonds, banks owned more reserve dollars. It has long been my contention that the “QE” was done to shore up bank capital and not, as many people thought, to increase the money supply. Despite the dramatic increase in bank reserve balances, the quantity of money did not make a comparable expansion. (See chart.) ![[Bernanke MZM v. Reserves.png]] # 0.0% Reserve Requirement ## Reserves Balance Since the Federal Reserve relinquished its indirect control of bank deposit liabilities during the quantitative easing phase in 2020, it took the unprecedented step of reducing reserve requirements to zero. Hypothetically establishing no limit to the amount of M-dollars that banks could create. (I will discuss in another post what keeps banks from creating unlimited quantities of M-dollars.) _(The following graphic shows the relationship between the quantity of bank reserves (R-dollars) and the quantity of money dollars (M-dollars) the bank could create based on the quantity of bank reserves (R-dollars) and the required reserve ratio of 0%. The bank has no obligation to create as many M-dollars as they may have authorization to create.)_ ![[Bank_Reserves 51.png]] ## Bank Account Balances The zero reserve requirement had little effect on the quantity of money dollars. Only during the government spending for Covid 19 relief did the quantity of money increase significantly. _(The following graphic shows quantity of M-dollars the bank creates and the total asset ==held by the bank== (R-dollars plus notes and securities purchased). The bank has no obligation to create as many M-dollars as they may have authorization to create. In the case of the elimination of the reerve requirement banks did not create more M-dollars or buy more assets.)_ ![[Bank_Balance_Sheet 51.png]] # Conclusion I cannot over-emphasize that The Federal Reserve does not create “money.” The Fed only creates reserve dollars (R-dollars). Only banks create money dollars (M-dollars.) As the reserve requirement lowers, (no comma) the capability of banks to create money dollars (M-dollars.) Over the years, because of the steadily declining reserve requirements, the influence of The Fed over the creation of money dollars (M-dollars) by banks has also steadily declined. During the financial crisis in 2008, The Fed increased the level of total reserves to the point of essentially relinquishing its leverage over the creation of M-dollars by banks. Although still a big player in the financial market, they reduced their role to just a player—in spite of retoric to the contrary. Be Careful what you believe about the Fed’s influence in markets and the economy.