In answer to Roy Weintraub, I think discussion of the role of bank 
reserves is exactly where reference to the history of economic 
thought is most desperately called for. Would that the Bank of 
England had remembered Bagehot in August-September 2007!

A propos James Ahiakpor's latest post, banks do indeed create money, 
because indeed "money is what money does", and demand deposits are 
transferred electronically to settle debts without the intermediation 
of cash, and banks do create demand deposits. QED.

True, banks initially create demand deposits by making loans via the 
cash base. But then the money multiplier comes into play, under the 
fractional reserve system. But having created M1 (and, indirectly, M2 
also), there are times, like now, when they stop relending 
(re-circulating) loans as they are repaid. This takes money out of 
circulation as they then hold a higher proportion of their 
(declining) asset base as reserves instead of loans.

That was known as liquidationism in the 1930s, and absent Fed support 
the money supply collapsed. Liquidationism is also what is happening 
now, with the credit crunch. Fortunately, this time the Fed has been 
intervening to hold up the cash base by bailing out the banks, 
permitting them to recapitalise without further destroying lending 
and spending.

Apparently James believes that only the cash base (his "classical" 
money) matters. If that holds up, is its velocity irrelevant? Why 
then is the world in recession? Obviously because MV has fallen even 
if M has not.

So we still need Keynes (as well as Hawtrey, and Hume brought up to 
date); that is, _right_ lessons from the history of thought.

Roger Sandilands