Economists’ Weasel Words 2: The ‘Money Supply’

Economists’ Weasel Words 2: The ‘Money Supply’

…..I recently had a conversation with somebody who told me he believed in ‘fiscal austerity plus monetary easing’. He defined ‘monetary easing’ as ‘increasing the money supply’. Thus his idea appears to be a version of  something over which there has been a lot of fussing in certain circles. Roughly: rather than pursuing fiscal stimulus by having the treasury run a deficit, why not have the central bank just ‘create money’ and give it out to people? Increase ‘the money supply’ rather than the deficit.

People who like this policy say that it would work as an economic stimulus. People who don’t like it say that it would be inflationary. Neither think very carefully about what they mean.

What does it mean for the central bank to ‘create money’? The central bank can, of course, credit the reserve accounts of banks, usually by lending against collateral. But this only increases the money(r) supply. Money(d) is the money that people actually spend; reserves cycle around in interbank settlements. So if we’re talking about something that could either work as economic stimulus or drive inflation, we must be talking about increasing the money(d) supply – say by crediting people’s bank accounts.

How can the central bank increase bank deposits? The only way to directly increase net bank deposits is to borrow from a bank. With a few legal adjustments, the central bank could do this. It could instruct banks to credit accounts up by a certain amount and then credit up their reserve accounts by a corresponding amount without taking any collateral. Very fancy, but remember that reserves are just liabilities of the central bank. So this operation actually amounts to the central bank taking out loans from the banks and then putting the new deposits into people’s accounts.

Don’t forget, either, that reserves are (in most countries at least) nominally backed by government debt. So the end result of the above-described operation is the same, in terms of the portfolio adjustments, as that of a fiscal deficit…….

About Kristjan

Defitsiidi terrorismi vastase pataljoni eriüksuslane (finantsignorantsuse vastu võitlemise osakond). Treening: MMT, postkeinsism, Tartu Ülikool Majandusteadus
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