Central Bank report: commercial banks create money, not central banks

category:Finance
 Central Bank report: commercial banks create money, not central banks


Commercial banks create money

According to the traditional view, the change of M2 is caused by the enlargement of monetary multiplier. Since the basic currency is mainly composed of cash, legal deposit reserve and excess deposit reserve, which is the main body of the central banks liabilities and the result of monetary policy implementation, it is close to the scale of the central banks balance sheet, so the change of the scale of the central banks balance sheet is easy to be regarded as the change of monetary policy orientation.

The central bank believes that in fact, there is no fixed correlation between M2 growth in broad sense and the size of the central banks balance sheet and the base currency.

The direct subject of broad money creation is the bank rather than the central bank. In reality, the broad money M2 is created by banks through credit expansion such as loans, which is realized by banks independently and does not need to use the basic currency.

In fact, the central bank provides credit loans to enterprises, and then forms the deposits of the enterprises. After the deposits are turned over to reserve funds, the loans are provided on the basis of the deposits, and then the deposits are formed. In this way, the multiple creation of deposits is formed. In the process of deposit creation, with the increase of enterprise loans, commercial banks play a role In fact, the base currency did not work.

What is the role of the central bank in this process? The central bank provides support and restraint for bank money creation by regulating the basic currency. In fact, when bank loans create deposit currency, it should transfer the excess deposit reserve which is equal to a certain proportion of the new deposit currency into legal deposit reserve according to the requirements of the central bank. In fact, by freezing some deposits, the ability of commercial banks to create money is weakened, But the central bank is not the main body of money creation.

Therefore, the excess deposit reserve is the liquidity of the banking system that can support the creation of bank money, while the legal deposit reserve is the liquidity of the banking system that has been frozen and cannot support the creation of bank money. The central banks balance sheet and base currency contain the sum of the above two items. The central bank believes that such analysis is of little significance for the orientation of monetary policy.

For example, before the 2008 international financial crisis, the size of the US Federal Reserves balance sheet remained basically unchanged, but monetary policy was changed mainly through policy interest rate adjustment. Another example is that from the beginning of 2000 to the end of 2013, the balance sheet of Chinas central bank has expanded 8 times, but during this period, Chinas monetary policy has experienced different orientations.

The central banks expansion is comparable to that of developed economies

The central bank also discussed that, if prolonged, Chinas central banks scale-up will be roughly the same as that of major developed economies. This also refutes many peoples criticism that the central banks balance sheet is expanding too fast.

From the beginning of 2000 to the end of September 2020, the balance sheet of Chinas central bank has expanded by 9.6 times, which is roughly the same as that of the Federal Reserve (9.5 times), the European Central Bank (7.1 times) and the Bank of Japan (5.2 times) in the same period.

Since the beginning of this century, Chinas central bank has been expanding its balance sheet passively, which is caused by the increase of foreign exchange funds. The corresponding basic currency growth mainly comes from the frozen legal deposit reserve. The reduction of the reserve ratio will unfreeze part of the legal deposit reserve into excess deposit reserve, which can increase the liquidity of the banking system and support the creation of money The base currency remains unchanged, and may even decrease in the short term as banks repay their loans to the central bank.

The large scale expansion of central banks in major developed economies began after the 2008 international financial crisis, which was caused by the further injection of liquidity through quantitative easing policy to stimulate the economy under the condition of the depletion of normal monetary policy space. The central banks scale expansion basically corresponds to the increase of excess deposit reserve, which is essentially different from that of China.

In recent years, with the end of the double surplus, the inflow of foreign exchange decreased, and even began to flow out. The Central Bank of China has got rid of the passive expansion mode caused by the increase of foreign exchange occupation. The autonomy of monetary policy has been significantly enhanced, and the role of banks as the center of money creation has been brought into full play.

Novel coronavirus pneumonia has been used by the PBC to hedge the impact of the new crown pneumonia epidemic since 2020, but it is reflected in the balance sheet of the central bank that the scale reduction and reexpansion of loans are offset each other. The scale of the Chinese central bank balance sheet remains basically stable, while the growth rate of the broad money M2 and the scale of social financing is significantly higher than that of 2019, and the comparison is mainly developed. The scale of the balance sheet of the Central Bank of the economy has increased significantly, which highlights that China has maintained normal monetary policy and conducted smoothly.

The constant ratio is a multiplier

The central bank emphasizes that the money multiplier is the constant ratio between the broad money m2 and the base currency. The creation of broad money M2 depends on the behavior of banks, and the demand for paying legal reserves generated by bank loans after creating deposits can be offset by reducing reserve requirements by reducing the balance sheet, or provided by refinancing instruments with expanded tables. This means that money multiplier is actually an identity result after the event, and there is no direct logical relationship between numerator and denominator. The traditional view of money multiplier reflects the mechanical observation of money creation. It does not fully realize that commercial banks are the main body of money creation, so it is not suitable for the practical analysis of money. Finally, the central bank concluded that there is no logical relationship between the central banks balance sheet size, monetary multiplier and the growth of broad money m2. As one of the few large economies in the world that still adhere to the normalization of monetary policy, China does not need to invest liquidity in the way of large-scale expansion of the central banks balance sheet, and it is not appropriate to measure goods simply according to the expansion range of the central banks balance sheet and monetary multiplier The effect of monetary policy. To observe the tightness of monetary policy, the key is to look at the money supply and the scale of social financing as the intermediary target of monetary policy. As long as the reasonable growth of money and credit is maintained, the market-oriented function of bank money creation is normal and the basic currency provided by the central bank is moderate. Source: China Times editor in charge: Chen Hequn_ NB12679

The central bank emphasizes that the money multiplier is the constant ratio between the broad money m2 and the base currency. The creation of broad money M2 depends on the behavior of banks, and the demand for paying legal reserves generated by bank loans after creating deposits can be offset by reducing reserve requirements by reducing the balance sheet, or provided by refinancing instruments with expanded tables. This means that money multiplier is actually an identity result after the event, and there is no direct logical relationship between numerator and denominator. The traditional view of money multiplier reflects the mechanical observation of money creation. It does not fully realize that commercial banks are the main body of money creation, so it is not suitable for the practical analysis of money.

To observe the tightness of monetary policy, the key is to look at the money supply and the scale of social financing as the intermediary target of monetary policy. As long as the reasonable growth of money and credit is maintained, the market-oriented function of bank money creation is normal and the basic currency provided by the central bank is moderate.