Tag Archives: Reserve requirement

Binswanger’s “Money Out of Nothing”

In his recent book Geld aus dem Nichts (Money out of Nothing), Mathias Binswanger discusses the role of banks in creating money, and money’s role in affecting the macro economy. The book is written for a non specialist audience and the arguments are often quite loose.

In the first part of the book, Binswanger describes how money mostly is created by commercial rather than central banks.

Part II provides a nice historical overview. Binswanger describes the origins of modern banking with goldsmiths first storing gold for their merchant clients, then lending some of the stored gold to third parties, and finally issuing more “receipts” than what corresponds to the gold deposits they actually accepted. From there, he argues, it was a small step to state licensed national banks like the Bank of England. On p. 120 Binswanger describes how minimum reserve requirements got out of fashion, not least because they suffered from circumvention when they were binding.

Part III lacks precision and is misguided (see also pp. 30 or 66). It covers the link between money creation and growth but confuses national accounting concepts and their relation to money and credit. Clearly, growth can occur without credit (think of an economy with just one agent to see this most directly) but Binswanger seems to dispute this point, in line with earlier writings by his father. A “model” on p. 144 does not help to clarify his views because it is orthogonal to the argument. Binswanger criticizes mainstream economics for refusing to accept the presence of long-run links between money and growth but this critique remains vain. Part IV deals with money creation and its effect on financial markets.

Part V, on reform, is sensible. Binswanger rejects proposals to move (back) to the gold standard or a 100%-money regime (or, essentially equivalent, “positive money”). His arguments against the Swiss “Vollgeld” initiative resonate with points I made here and elsewhere, including the point that it would be difficult to enforce a “Vollgeld” regime (see also p. 122). Binswanger criticizes the “Vollgeld” initiative’s vagueness concerning actual implementation of monetary policy. He ends with more limited, rather standard proposals (relating to regulation, monetary policy objectives and capital requirements) to address problems in financial markets.

Reserve Requirements

Pablo Federico, Carlos Vegh and Guillermo Vuletin discuss legal reserve requirements in an NBER working paper.

Their data set covers 15 industrial and 37 developing countries over the period 1970–2011. Developing countries typically actively manage legal reserve requirements in the sense of adjusting them at least once over the business cycle. Industrialised countries don’t. None of the latter has changed the requirements after 2004, and many have no requirements at all. Among the active countries, most conduct a counter cyclical reserve requirements policy, often in contrast to a more pro cyclical monetary policy along other dimensions.

“Vollgeld, Liquidität und Stabilität (100% Money, Liquidity and Stability),” NZZ, 2014

Neue Zürcher Zeitung, May 12, 2014. PDF. Extended version in Ökonomenstimme, May 13, 2014. HTML.

  • A 100% money regime reduces the risk of credit bubbles, but requires more and better fine-tuning by the central bank.
  • Central banks can already implement higher reserve requirements. If the fact that they don’t reflects policy failure, then the 100% money proposal risks handing more power to one source of the problem.
  • A 100% money regime increases financial stability, at least temporarily, but it forces banks to find new sources of funding and lowers the interest rate for depositors, which is fine.
  • If lender of last resort support by the central bank occurs at too low interest rates then seignorage revenues are privatised and costs socialised under the current regime. Moving to a 100% money regime would help but so would simple Pigouvian taxation.
  • How can a 100% money regime be enforced if market participants end up coordinating to use other securities than deposits as means of payment?
  • More stable deposits in a 100% money regime do not imply a more stable banking system unless other regulation is imposed that completely prevents “maturity transformation.”
  • Aggregate liquidity cannot be created out of nothing, with or without deposit insurance.
  • Societies have to take a stand on whether they want to guarantee broader monetary aggregates than base money. If so, the cost of the guarantee should be privatised. Problems arise if societies pretend not to provide such guarantees but central banks nevertheless feel obliged to step in ex post and market participants are aware of that fact ex ante; bad, self-fulfilling equilibria are the consequence.
  • Commitment on the part of policy makers is key; it requires independent central bankers and regulators.

History of Finance and Financial Regulation

The Economist reviews the history of finance and financial regulation, arguing that

institutions that enhance people’s economic lives, such as central banks, deposit insurance and stock exchanges, are not the products of careful design in calm times, but are cobbled together at the bottom of financial cliffs. Often what starts out as a post-crisis sticking plaster becomes a permanent feature of the system. … The response to a crisis follows a familiar pattern. It starts with blame. New parts of the financial system are vilified: a new type of bank, investor or asset is identified as the culprit and is then banned or regulated out of existence. It ends by entrenching public backing for private markets: other parts of finance deemed essential are given more state support.

The Economist identifies five major events that shaped modern finance:

  • Hamilton’s bank bailout in 1792.
  • The creation of joint-stock banks in England after the “emerging markets” crisis of 1825.
  • The railroad crash of 1857, global panic and the Bank of England’s stricter requirements for discount houses to hold cash.
  • Financial fraud and low cash holdings, the 1907 panic, the National Monetary Commission’s demand for a lender of last resort and the 1913 Federal Reserve Act establishing the (third) central bank in the US.
  • Recession and financial meltdown in 1929, the bank holiday of 1933, publicly funded bank recapitalization, Glass-Steagall and the FDIC.