It is interesting: professor Ahiakpor takes us back to Cannan's notion of "cloakroom banks", whereby banks are mere intermediaries between depositors and borrowers. New lending originates in a reduction in depositors' preferred cash-to-deposit ratio. 
But what if: 
(i) given the public's preferred cash-to-deposits ratio, the foreign reserves of the central bank rise as a consequence of an external surplus? Or if the central bank reduces the reserve requirement ratio? 
(ii) if all banks move "forward in step"? if a single commercial bank initiates the expansion of credit it may "run out" of cash. But if the whole banking system does so "in step", every loan is by definition a new deposit. Loans create deposits, not the other way around. The only limit to the expansion of loans, in an open economy,  is the foreign reserves of the Central Bank.

Because this discussion has relevant macroeconomic implications, it may be useful to concentrate not just on the microeconomics of one single bank considered as an individual firm, but on the banking system as a whole.
 
By the way, as to the "writers on finance" referred to by Professor Offer, we may add Knut Wicksell and  Dennis Robertson.

Regards

Lilia Costabile






Il giorno Nov 21, 2013, alle ore 10:43 PM, James C.W. Ahiakpor <[log in to unmask]> ha scritto:

> Unfortunately, the idea that banks lend more than each depositor's savings with them appears well entrenched in some people's minds.  They are convinced of that by the formula describing the total of deposits in a banking system, D = dDo, where d = 1/(cu + rd + re), the deposit multiplier,  Do is the initial cash deposit that starts a deposit expansion process, and D is the sum total of deposits.  The problem is that not sufficient care is taken by some writers to clarify the process.  A good reference to the process's clarity is Adam Smith's (_Wealth of Nations_) chapter, "Of Stock Lent at Interest."  There Smith explains that in the process of lending, "money is, as it were, but the deed of assignment, which conveys from one hand to another those capitals [savings] which the owners do not care to employ themselves.  Those capitals may be greater in almost any proportion, than the amount of the money [cash] which serves as the instrument of their conveyance; the same pieces of money successively serving for many different loans, as well as for many different purchases" (Chicago: 1976, 374).  In the modern deposit creation formula, Do is the equivalent of Smith's money that carries the first saver's deposit to the bank.
> 
> Indeed, if any bank could lend more than deposited with it, it could just as well create deposits out of thin air and never bother about deposits.  The fact of the matter is that banks always lend a fraction of their deposits, albeit a substantial fraction.  That is indicated in the formula, BCo = (1 - rd)(1 - re)Do, where BCo is bank credit, rd = required reserve to deposit ratio, and re = bank's economic or excess reserve to deposit ratio, and Do = the initial deposit (cash) that starts the process.  When the first loan (BCo) created on the basis of Do comes back as a new deposit (savings), it will be D1 = (1 - cu)BCo = (1 - cu)(1 - rd)(1 - re)Do, where cu = the income recipient's currency to deposit ratio or currency drain.  Thus, the next loan created will be a smaller magnitude than the first, being BC1 = (1 - rd)(1 - re)D1, and so on.
> 
> The suggestion of 100 per cent reserve to deposit ratio by the likes of Irving Fisher, Henry Simon, and Milton Friedman was motivated by the concern that banks always have cash reserves to pay each depositor's claims.  (Murray Rothbard's endorsement of that policy stems from his belief that fractional-reserve banking constitutes a fraud on the part of banks.)  It was not made with the understanding that banks lend more than each depositor's savings.  That would be erroneous.  In a fractional reserve system, which also means that banks lend less than 100 per cent of each depositor's savings, banks never can meet all of their liabilities when depositors demand redemption in cash at the same time.  Indeed, some textbooks teach the deposit expansion process without paying careful attention to the fact that it is the subsequent savings of those who earn incomes from loan expenditures that make new loans possible.  The careful authors don't do that.  I make sure, when I teach the deposit expansion process, that my students understand this.
> 
> James Ahiakpor
> 
> Avner Offer wrote:
>> Dear James,
>> 
>> Your write in exasperation ‘What am I supposed to do with [it]?’ , as if you possess revealed truth. Your exasperation suggests that economics textbooks du jour are holy writ, and assumes that you read them correctly (see Alan Isaac’s response).
>>  Putting Keynes to one side, if economists and bankers had a correct understanding of money and banking, we would not have had such a financial crisis.
>> 
>> For the many historical ‘writers in finance’ I allude to see i.a. Schumpeter, History of Economic Analysis (1954), IV.8.7, pp. 1111-1116 (‘Bank Credit and the ‘Creation’ of Deposits’). Among such notable writers were also Irving Fisher, Henry Simons and Milton Friedman, all of whom proposed at one time or another a 100% reserve system of banking, to prevent bankers from creating ‘checkbook money’. (Hixson, A Matter of Interest, 247-248).
>> 
>> The argument is not that all loans are made out of thin air, but that some fraction of them are, constrained by the risk that bankers feel able to take. They lend bank-made-money, take collateral, and earn interest. Ultimately, banks need to be able to satisfy liabilities in legal tender.
>> 
>> The bank does lend out its deposits and gets a mark-up. The risk is that all depositors will ask for their money at once. But they don’t. So the bank lends more than it has on deposit, some of it comes back as new deposits, it lends a little more than that and so on. How much new money to create is a matter of discretion, constrained (micro) by the quality of the borrower and (macro) by economic performance overall.
>> 
>> Banks need the cushion of deposits to create new money, hence deposit and loan rates move together. There are (and have been) various classes of deposits that pay no interest, or indeed incur a charge.
>> 
>> Commercial banks need to borrow from other banks when demands for payment (e.g. that check from the car dealer) come in and they have no legal tender to pay it with, or not enough to take on more risk. Likewise with borrowing from the central bank. In the extreme case, caused by a run on the bank, they pay more interest to the central bank because other banks won’t lend to them. In fact commercial banks have learned by now that they won’t even have to pay that penalty.
>> 
>> It isn’t any institution that can create a loan out of nothing, only institutions licensed to do so. That’s one reason why bankers are rich, and why (when improperly regulated), banks come to grief.
>> 
>> ‘His bank manager’ – what a quaint notion. In this town there are no longer local ‘bank managers’ with discretion over lending. Nor is it clear that traditional small-town bank managers fully understood that they were creating new money when they lent. Economists seem to have trouble with this idea as well.
>> 
>> Your final paragraph is technically correct, but the scope for hoarding (of banknotes or precious metal) is quite limited.
>> 
>> Avner Offer
>> 
>> 
>> ======================================================
>> From Avner Offer, Chichele Professor Emeritus of Economic History, University of Oxford
>>   All Souls College, High St., Oxford OX1 4AL, tel. 44 1865 281404
>>  email: [log in to unmask]
>>  personal website:
>>  http://sites.google.com/site/avoffer/avneroffer
>> ________________________________________
>> From: Societies for the History of Economics [[log in to unmask]] on behalf of [log in to unmask] [[log in to unmask]]
>> Sent: 20 November 2013 23:31
>> To: [log in to unmask]
>> Subject: Re: [SHOE] The Keynesian multiplier
>> 
>> On 11/19/2013 1:09 PM, Avner Offer wrote:
>>> "Lenders don't generate their sources of funds from thin air."
>>> 
>>> Are you arguing that every dollar lent has to be deposited first by a saver, i.e. withdrawn from consumption? As writers on finance have known for a very long time, it is almost the opposite: a substantial proportion of bank deposits are created by loans credited to borrowers.
>>> 
>>> Avner Offer
>>> 
>>> ======================================================
>>> >From Avner Offer, Chichele Professor Emeritus of Economic History, University of Oxford
>>>    All Souls College, High St., Oxford OX1 4AL, tel. 44 1865 281404
>>>   email: [log in to unmask]
>>>   personal website:
>>>   http://sites.google.com/site/avoffer/avneroffer
>> Avner Offer is here repeating Keynes's (1930) fallacious claim that I
>> noted earlier.  What am I supposed to do with?  I also don't know who
>> these "writers on finance" are who would claim that "a substantial
>> portion of bank deposits are created by loans credited to borrowers."
>> Now  if a bank credits a borrower's account with, say, $10,000 and the
>> borrower writes a check for $10,000 to pay for a car.  The car seller
>> deposits the check in the company's bank account and the bank sends the
>> check for collection to the originator (bank) of the loan.  If the
>> originator of the loan didn't have $10,000 to meet the claim, what
>> happens to that bank?
>> 
>> Perhaps, Avner is not very familiar with money and banking or the
>> process of financial intermediation; a good introductory macroeconomics
>> text teaches the principle, too.  To help Avner think clearly about the
>> necessity of banks having deposits (savings) prior to lending, s/he
>> should answer the questions: If banks can create credit without prior
>> savings, why would they pay interest to savers for their deposits?  Why
>> is it that deposit rates and loan rates move up and down together, the
>> spread being fairly constant?  Why would some banks borrow from other
>> banks (the Federal Funds market in the U.S.) if they could just create
>> credit on their own to lend? Why would banks borrow from a central bank
>> (at interest, typically higher than they would pay other banks) if they
>> could create their own loans without prior savings?  Finally, if any
>> institution (other than a central bank) could create a loan without
>> prior savings, why would anyone want to be a borrower?
>> 
>> I suggested to Rob Leeson that he take a look at a good book on money
>> and banking to understand the sources of bank funds as well as the uses
>> of such funds (loans and investments).  I also suggested a visit with
>> his bank manager.  The same suggestions are suitable for Avner Offer as
>> well.
>> 
>> One's disposable (after-tax) income may be used to purchase consumption
>> goods, acquire financial assets (savings), and held in cash (hoarding).
>> Thus, there could be increased saving without a reduction in consumption
>> spending when people reduce their cash hoarding. Similarly, there could
>> be a decrease in the flow of savings without an increase in consumption
>> spending when people turn more of their income into demanding more cash
>> to hold.
>> 
>> James Ahiakpor
>> 
>>> ________________________________________
>>> From: Societies for the History of Economics [[log in to unmask]] on behalf of [log in to unmask] [[log in to unmask]]
>>> Sent: 19 November 2013 20:12
>>> To: [log in to unmask]
>>> Subject: Re: [SHOE] The Keynesian multiplier
>>> 
>>> On 11/19/2013 1:28 AM, Robert Leeson wrote:
>>> 
>>> As I made clear in November 2011, it is evidence that the assumption has been falsified that James is requested to provide.
>>> 
>>> RL
>>> 
>>> 
>>> Sorry I did not answer Rob's the question as he intended.  I thought the fact that savings are spent by borrowers was much too obvious for him to have been asking for such proof or "evidence".   So here is the proof of Keynes's error.  Any time anyone takes a loan -- car loan, home mortgage, consumer loan, or uses a credit card to make a purchase -- they prove Keynes's understanding of saving to be wrong.  Such proof is going on everyday, except that the unrepentant Keynesians don't recognize it.
>>> 
>>> Lenders don't generate their sources of funds from thin air.  They issue IOUs that are "purchased" by savers, except central banks that create credit out of nothing.  That is why one reads from Adam Smith that saving is the acquisition of interest- or dividend-earning assets.  Alfred Marshall, who tried unsuccessfully to teach economics to Keynes, also makes the point when he explains that "in 'western' countries even peasants, if well to do, incline to invest the greater part of their savings in Government, or other familiar stock exchange securities, or to commit them to the charge of a bank" (1923, 46; my emphasis); cited on page 15 of the 1998 volume to which Rob Leeson contributed a chapter.  Marshall is here elaborating J.S. Mill's (Works, 2: 70) explanation of the meaning of saving, partly cited on page 14 of the same 1998 volume.
>>> 
>>> We (at least, I do) explain this principle when teaching the bank deposit multiplier process: someone takes their savings (in cash) to deposit in a bank and the bank lends a fraction of that, BC = (1 - r)D, and so on.  (Even when one deposits a check, the check is an order to pay money (cash), ultimately.)  Texts in money and banking provide country-wide data on banks' sources of funds (savings) and uses of funds (loans and investments).  Rob can look up the data from any good money and banking text; I use these days R.Glenn Hubbard and Anthony O'Brien's, Money, Banking, and the Financial System.   Otherwise, Rob can go to his bank's manager.  In humility, he should ask the manager from where the bank gets its funds to lend.  If, instead, he takes Keynes's (1930, 25) arrogant position that explanations of "Practical bankers, like Dr. Walter Leaf" that banks depend upon their depositors' savings to lend to be not "the commonsense which it pretends to be," he would come away without learning anything.
>>> 
>>> Clearly, the inclusion of cash hoarding in the definition of saving is the "trap door" for Keynes and Keynesians in their understanding of the classical explanation that savings are spent by borrowers.  The demand for money (cash) is for an asset to hold, but the demand for credit (loan) is for a facility to spend without using one's income.  Loans are funded by savings.  What's so hard to understand about that?   BTW, I meant to cite Joan Robinsion (1960, 27) yesterday: "If private saving is going on, there is a leakage of notes [cash] out of circulation into hoards."  And this is the foundation for the mythology of Keynes's  "paradox of thrift"!
>>> 
>>> James Ahiakpor
>>> 
>>> 
>>> ----- Original Message -----
>>> From: "[log in to unmask]"<mailto:[log in to unmask]> <[log in to unmask]><mailto:[log in to unmask]>
>>> To: [log in to unmask]<mailto:[log in to unmask]>
>>> Sent: Tuesday, 19 November, 2013 5:47:10 AM
>>> Subject: Re: [SHOE] Where are the ex-Austrians?
>>> 
>>> On 11/18/2013 1:27 AM, Robert Leeson wrote:
>>> 
>>> 
>>> "Keynes's multiplier argument is founded upon three fundamental assumptions that turn out to be false: (1) that savings are not spent but are a withdrawal from the expenditure stream ..."
>>> 
>>> Since James also made this assertion in November 2011, perhaps he can now provide some evidence to support it.
>>> 
>>> RL
>>> 
>>> 
>>> It's incredible to me that someone writing on the History of Economic
>>> Thought list wants "evidence" that Keynes considered saving not to be
>>> spending by income earners but a withdrawal from the expenditure
>>> stream!  Incredible also because every introductory macroeconomics
>>> students learns that meaning of saving.  Anyhow, Robert can look up
>>> Keynes's meaning of saving in the _Treatise_ (1930), volume 1, p. 172,
>>> the _General Theory_ (1936), pp. 74 and 210; Keynes's _Economic Journal_
>>> articles (December 1937) and (June 1938).  (Joan Robinson, _EJ_, 1938
>>> repeats Keynes's definition of saving to mean a withdrawal from the
>>> expenditure stream.)  Robert can also check these pieces of evidence, in
>>> contrast with the classical explanation that savings are spent by
>>> borrowers, that is, saving is not cash hoarding (Smith, Ricardo, and
>>> J.S. Mill) in chapter 2 of _Keynes and the Classics Reconsidered_
>>> (Kluwer, 1998), a volume to which he contributed a chapter (7).
>>> 
>>> James Ahiakpor
>>> 
>>> 
>>> ----- Original Message -----
>>> From: "James C.W. Ahiakpor" <[log in to unmask]><mailto:[log in to unmask]>
>>> To: [log in to unmask]<mailto:[log in to unmask]>
>>> Sent: Monday, 18 November, 2013 5:27:45 AM
>>> Subject: Re: [SHOE] Where are the ex-Austrians?
>>> 
>>> Steve Kates wrote:
>>> 
>>> 
>>> I think there should be a Godwin's Law for Economics. Whoever brings
>>> empirical results into a theoretical discussion automatically loses.
>>> 
>>> It should not be thought that I stepped back very far when I agreed
>>> that the failure of the stimulus is not obvious. It's obvious that
>>> it's not obvious, since this will remain an open and never ending
>>> debate for as long as economists exist.
>>> 
>>> But so far as the economic policy side is concerned, there is no
>>> waiting around for academic economists to decide which way is up. With
>>> the sequestration in the US and other similar actions across the world
>>> by those who are trying to manage their economies, this is a debate,
>>> that for the time being anyway, is resolved. No country in the world,
>>> with the possible exception of the US, would try to stimulate their
>>> economies through additional levels of public spending. The recessions
>>> are not over. Economic conditions are worse than in 2008. But
>>> increases in public spending are off the table everywhere. If we can't
>>> even agree on that, then what can anyone ever say that can be a
>>> foundation for further discussion.
>>> 
>>> 
>>> 
>>> 
>>> I think for any law to be useful, there has to be a mechanism for its
>>> enforcement.  That is why I despair at Steve's suggestion.  Who will
>>> enforce Godwin's Law for Economics?  I also think data or empirical
>>> results can be useful in a "theoretical" discussion. After all, aren't
>>> theories supposed to be evaluated with evidence to ascertain their
>>> reliability?  I believe a more useful approach to dealing with
>>> "empirical results" used to affirm a certain belief system is rather to
>>> examine the nature of the data used to estimate the results as well as
>>> the methodology employed in constructing the functional form or
>>> estimating equation.  On that basis, it is easy (for me, at least) to
>>> dismiss the meaningfulness of estimated government expenditure
>>> multipliers as a basis for belief in Keynesianism, particularly fiscal
>>> stimulus.
>>> 
>>> Keynes's multiplier argument is founded upon three fundamental
>>> assumptions that turn out to be false: (1) that savings are not spent
>>> but are a withdrawal from the expenditure stream, (2) that government
>>> (and business) expenditures don't depend upon income or savings (even
>>> for a closed economy), and (3) that consumption spending takes a
>>> unidirectional form, like running a relay race -- A's consumption
>>> becomes B's income, then B's consumption becomes C's income, and so on.
>>> Now if one corrects assumption (1) to realize that savings fund business
>>> investments as well as government budget deficits, and (2) that
>>> government spending has to be financed by taxes (paid out of income) and
>>> there cannot be any measured consumption expenditures without any
>>> current production and sales--so-called "autonomous consumption" for the
>>> economy as a whole, then the expenditure multiplier has to be equal to
>>> infinity. But there is also nothing left to multiplier it by.  That's
>>> why the government expenditure multiplier EFFECT is zero.
>>> 
>>> No amount of fooling around with functional forms negates the above
>>> conclusion.  There is thus no point, as far as I'm concerned, arguing
>>> with someone who insists on basing their belief in Keynesianism on
>>> estimated multipliers.  I published the "mythology of the Keynesian
>>> multiplier" in the _American Journal of Economics and Sociology_ in 2001
>>> and I repeat the point in footnote 20, p. 87, of my modern Ricardian
>>> equivalence article in the _Journal of the History of Economic Thought_
>>> (March 2013).  How else can I hope to persuade a non-repentant Keynesian
>>> (who also claims to be a historian of economic thought) of the folly of
>>> such belief?  If one introduces central bank new money creation into the
>>> argument, then we would have an explosive multiplier effect on real
>>> income (output and employment) nowhere observed on earth! As Murray
>>> Rothbard once observed, regarding the silliness of the Keynesian
>>> multiplier argument, all government needs to do to create prosperity for
>>> ever is just to find just 1 dollar to spend.
>>> 
>>> Indeed, I think such "studies" as publicized by Alesina without getting
>>> to the heart of the Keynesian mythology don't serve a very useful
>>> purpose.  They are rather a distraction.  Aggregate data are generated
>>> by a multitude of factors (or impulses, the favorite language of the
>>> econometric estimators).  Without carefully identifying them and
>>> isolating their respective impacts on observed data, no estimation tells
>>> a useful story about the economy.  This is what we learn from
>>> econometrics.  And this is also why someone once wrote about the two
>>> things he wouldn't like to see in their preparation: sausages and
>>> econometric estimation, the latter because many unsavory things can be
>>> done to generate the end result!
>>> 
>>> James Ahiakpor
>>> 
>>> 
>>> On 17 November 2013 00:53, Alan G Isaac <[log in to unmask]<mailto:[log in to unmask]>
>>> <mailto:[log in to unmask]><mailto:[log in to unmask]>> wrote:
>>> 
>>>       On 11/16/2013 8:36 AM, Alan G Isaac quoted:
>>> 
>>>                 "The range of the spending multiplier estimated using
>>>                 these various approaches is from .4 to 1.5, with some
>>>                 estimates even lower than .4 and some estimates larger
>>>                 than 1.5.  However, most fall in the .4 to 1.5 range."
>>> 
>>> 
>>> 
>>>       If I may offer just one more quote from some people who care about
>>>       the evidence.
>>>       Jordà, Òscar  and Alan M. Taylor, 2013,
>>>       "The Time for Austerity: Estimating the Average Treatment Effect
>>>       of Fiscal Policy"
>>>       http://www.nber.org/papers/w19414
>>> 
>>>               "<http://www.nber.org/papers/w19414>[W]e have a measure of the multiplier that
>>>               explicitly accounts for failures of identification
>>>               due to observable controls.  Our estimates ...
>>>               suggest even larger impacts than the IMF study when
>>>               the state of the economy worsens. ...  It appears
>>>               that Keynes was right after all."
>>> 
>>>       As Steve now allows, it is *not* obvious that the fiscal responses
>>>       to the Great Recession invalidate Keynesian claims about the
>>>       role of aggregate demand.  Not in the least.
>>> 
>>>       Cheers,
>>>       Alan Isaac
>>> 
>>> 
>>> 
>>> 
>>> 
>>> 
>>> 
>>> 
>>> 
>>> 
>>> 
>>> --
>>> James C.W. Ahiakpor, Ph.D.
>>> Professor
>>> California State University, East Bay
>>> Hayward, CA 94542
>>> 
>>> (510) 885-3137
>>> (510) 885-7175 (Fax: Not Private)
>>> 
>>> 
>> 
>> --
>> James C.W. Ahiakpor, Ph.D.
>> Professor
>> California State University, East Bay
>> Hayward, CA 94542
>> 
>> (510) 885-3137
>> (510) 885-7175 (Fax: Not Private)
> 
> 
> -- 
> James C.W. Ahiakpor, Ph.D.
> Professor
> Department of Economics
> California State University, East Bay
> Hayward, CA 94542
> 
> (510) 885-3137 Work
> (510) 885-7175 Fax (Not Private)
>