Home > Uncategorized > Central Bankers: ‘We’re all Post-Keynesians now’

Central Bankers: ‘We’re all Post-Keynesians now’

from Jesse Frederik (guest post)

Does the ‘money multiplier’, this core concept of monetary theory, exist? Do banks need reserves before they create money? Not according to central bankers. Banks can create money at will, even without reserves, though they will have to find or borrow these reserves afterwards. But as the central bank has to provide these, this is not any kind of  constraint, even when the central bank increases the rate of interest. Some quotes which imply that central banks can not control the amount of money by influencing reserves:

Alan R. Holmes, Federal Reserve Bank of New York (1969):

‘In the real world, banks extend credit, creating deposits in the process , and look for the reserves later.’

Nobelpricewinners Finn Kydland en Ed Prescott , Federal Reserve bank of Minneapolis (1990):

There is no evidence that either the monetary base or M1 leads the [credit cycle], although some economists still believe this monetary myth. Both the monetary base and M1 series are generally procyclical and, if anything, the monetary base lags the [credit cycle] slightly.’

Charles Goodhart, member of the Monetary Policy Committee of the Bank of England (2007):

The money stock is a dependent, endogenous variable. This is exactly what the heterodox, Post-Keynesians, from Kaldor, through Vicky Chick, and on through Basil Moore and Randy Wray, have been correctly claiming for decades, and I have been in their party on this.’

Piti Distayat en Claudio Bori, Bank for International Settlements (2009):

‘This paper contends that the emphasis on policy-induced changes in deposits is misplaced. If anything, the process actually works in reverse, with loans driving deposits. In particular, it is argued that the concept of the money multiplier is flawed and uninformative in terms of analyzing the dynamics of bank lending. Under a fiat money standard and liberalized financial system, there is no exogenous constraint on the supply of credit except through regulatory capital requirements. An adequately capitalized banking system can always fulfill the demand for loans if it wishes to.’

Seth B. Carpenter, Federal Reserve (2010):

‘Changes in reserves are unrelated to changes in lending, and open market operations do not have a direct impact on lending. We conclude that the textbook treatment of money in the transmission mechanism can be rejected. Specifically, our results indicate that bank loan supply does not respond to changes in monetary policy through a bank lending channel.

Vitor Constancio, vice president of the ECB (2011):

‘It is argued by some that financial institutions would be free to instantly transform their loans from the central bank into credit to the non-financial sector. This fits into the old theoretical view about the credit multiplier according to which the sequence of money creation goes from the primary liquidity created by central banks to total money supply created by banks via their credit decisions. In reality the sequence works more in the opposite direction with banks taking first their credit decisions and then looking for the necessary funding and reserves of central bank money.

Update (31-3-2012): see also THE OPERATIONAL TARGET OF MONETARY POLICY AND THE RISE AND FALL OF RESERVE POSITION DOCTRINE by Ulrich Bindseil (2004), at the time head of liquidity management of the ECB:

“From today’s perspective, one could feel that academic economists unconsciously colluded in their distaste for re-questioning the applicability of macro-economic models on dayto-day implementation of monetary policy, and their lack of willingness to study the actualfeatures of money markets and monetary policy operations. As Goodhart (2001) puts it: “largeparts of macro-economics are insufficiently empirical; assumptions are not tested against facts. Otherwise, how could economists have gone on believing that central banks set H [the monetary base] and not i? In so far as the relevant empirical underpinnings of macro-economics are ignored, undervalued or relatively costly to study, it leaves theory too much at the grasp of fashion, with mathematical elegance and intellectual cleverness being prized above practical relevance.” Unfortunately, it needs to be admitted that the list of RPD (Reserve Position Doctrine, MK) inspired papers that contain empirical (econometric) analysis is long.”


It seems also noteworthy that both groups, academic economists and central bankers, showed little interest in studying well-documented historical experience (e.g. Bagehot, 1873, King, 1936, Sayers, 1976). Overall, the 20th century thus seemed to have witnessed in the domain of monetary policy implementation a strange symbiosis between academic economists stuck in
reality-detached concepts, and central bankers who were open to such concepts, partially since they allowed to avoid explicit responsibility. Masking responsibility seemed to be of particular interest whenever the central bank’s policies were strongly des-inflinflationary and thus causing recession and unemployment (in the US in 1919-21 and in 1979-82).

And a nice Hayek quote (HT John Papola):

“In view of the apparently widespread impression that the influence of liquidity considerations on the rate of interest is a new discovery, the present author may perhaps be excused for pointing out that more than ten years ago he described cyclical fluctuations as largely due to the fact that the rate of interest is in the short term ‘determined by considerations of banking liquidity‘

(Hayek, Geldtheorie and Konjunkturtheorie (Vienna: Holder-Pichler-Tempsky, 1929, p. 103). – F. A. Hayek, The Pure Theory of Capital, 1941/2007, p. 326.

  1. January 27, 2012 at 2:21 am

    Deception is an integral part of the banking system.
    For example, new loans appear in bank financial statements on both sides of the ledger, as “loans” on the asset side and as “deposits” on the liability side of the bank’s balance sheet. The wording used on the balance sheet creates the impression that the bank is lending out an amount equal to about 90% (on average, say) of the amount listed as deposits, making non-banking people believe that most of these deposits have arrived from some source outside of the bank, when, in fact, a large percentage have been created within the bank’s accounting system by a keystroke.

  2. January 27, 2012 at 12:27 pm

    Excellent collection of quotes, thank you. As a student was always confused because my textbook said “if the central raises the money supply by x percent” whereas the newspapers said “the central bank has raised the interest rate by x points”. So I was wondering “What does the central bank actually do? Does it control the money supply or the interest rate?”. In the end it didn’t matter because it was possible to pass the exam without properly understanding this problem.
    Now I know more.

  3. Peter T
    January 28, 2012 at 10:48 am

    This is essentially Steve Keen’s view – see http://debunkingeconomics.com/ .

    I would add that it seems to me that much discourse confuses the unit of account with the medium of exchange. The latter can be created by anyone who finds someone else willing to accept a transferable IOU in exchange for some good or service. It’s all denominated in dollars or euros, but the IOUs differ in their soundness – “money” is created when companies issue shares, merchants accept credit cards and so on. So money can be viewed as a debt, and the issue with a debt is whether and on what terms it will be repaid. One of the games is to trade up riskier debt (shares, CDOs, loans) into higher grade debt. And the highest grade debt of all is that backed by states. We need to ask not only how much money is in circulation, but also what kinds, and how sound.

    Not an original thought – JK Galbraith noted the same thing in C19 America – the frontier wanted easy (low grade) money to facilitate expansion, the East Coast wanted hard money to facilitate trade with Europe, and the tussle was the terms of exchange.

    • Dave Taylor
      January 28, 2012 at 2:25 pm

      A very lucid and thought-provoking comment. Isn’t this problem of confusion due to economists still thinking in terms of one-dimensional numbers and ‘either/or’, having forgotten Pythagoras’s two-dimensional “square on the hypotenuse” and remained blissfully unaware of the logical significance of two-dimensional complex numbers? If the IOU is understood to be a complex number, its projections on vertical and horizonal dimensions might be referred to as ‘Value of IOU’ and ‘Reliability of IOU’, the reliability being real and positive (though less than one) and the account value, appropriately, both imaginary and negative (when viewed as debt).

      I agree entirely that “the issue with a debt is whether and on what terms it will be repaid”. Since the monetary debt is imaginary it should NOT be repaid, but accounted for. The real debt is the goods supplied when the IOU (perhaps discounted in light of its unreliability) is accepted as payment, and the only way that can be repaid is by regenerating what is consumed. It is not a law of nature but a social choice as to whether we settle our accounts by banking employers’ IOU’s for that work, or by everyone enjoying a Citizen’s Income and being disciplined to cooperate with others or employ themselves. As we’re seeing again, the former choice leads to winters of discontent. The other would free us to enjoy our winters when we have done our work and the harvest is in.

  4. Nathan Tankus
    March 31, 2012 at 5:17 am

    “The use of RR to support prudential requirements and monetary control is largely outdated, and can be more effectively met, in most cases, by use of other tools. But in some markets, in some circumstances, active use of RR may make sense.
    Central banks should normally manage reserves in an accommodating manner, in order to avoid the unwanted consequences of a surplus or shortage of reserve balances.”



    add them to the list.

  5. Jonas
    April 30, 2017 at 12:07 pm

    So all these citations come from central bankers. They are the root, cause and the reason of money supply. And all they can not agree on their faults on creation surplus money that leads to crisis. it is strange – central bank fully controls commercial banks and somehow they blame commercial banks for expanding credits and money supply. Btw, where did the funds from open market operations go? Are’nt they a part of money creation and supply?

  1. March 31, 2012 at 4:08 pm
  2. March 26, 2013 at 3:49 pm
  3. October 25, 2013 at 8:44 am
  4. February 7, 2014 at 12:53 am

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