Tag Archives: Consumption

Banks Are Not Intermediaries of Loanable Funds

In a recent Vox blog post, Zoltan Jakab and Michael Kumhof argue that macroeconomic models where banks intermediate loanable funds get it seriously wrong.

In the intermediation of loanable funds model, bank loans represent the intermediation of real savings, or loanable funds, between non-bank savers and non-bank borrowers … [but in reality] [t]he key function of banks is the provision of financing, meaning the creation of new monetary purchasing power through loans, for a single agent that is both borrower and depositor.

This difference has important implications. Compared to intermediation of loanable funds models, money creation models predict larger and faster changes in bank lending and real activity; pro- or acyclical rather than countercyclical bank leverage; and quantity rationing of credit after contractionary shocks. New loans in loanable funds model are accompanied by additional savings and thus, higher production or lower consumption. In money creation models, in contrast, they simply reflect an expansion of banks’ balance sheets that is only checked by profitability and solvency consideration. Moreover, “the availability of central bank reserves does not constitute a limit to lending and deposit creation. This … has been repeatedly stated in publications of the world’s leading central banks.”

A large part of [money creation banks’] response [to a contractionary shock], consistent with the data for many economies, is … in the form of quantity rationing rather than changes in spreads. … In the intermediation of loanable funds model leverage increases on impact because immediate net worth losses dominate the gradual decrease in loans. In the money creation model leverage remains constant (and for smaller shocks it drops significantly), because the rapid decrease in lending matches (and for smaller shocks more than matches) the change in net worth. … As for the effects on the real economy, the contraction in GDP in the money creation model is more than twice as large as in the intermediation of loanable funds model, as investment drops more strongly than in the intermediation of loanable funds model, and consumption decreases, while it increases in the intermediation of loanable funds model.