So, fractional reserve banking.

[Zippyjuan]

How do you explain such growth in credit then as monetary base remained relatively flat(pre 2008)?

What is in the monetary base? The monetary base is the amount of cash in the system combined with the amount of excess reserves banks keep with the Federal Reserve. If they aren't keeping lots of excess reserves (like they are now), the monetary base is lower. They currently have about $2 trillion in excess reserves. That is money not getting lent out. If they are making loans (such as during the housing bubble), they have fewer excess reserves and the monetary base is lower.

The Adjusted Monetary Base is the sum of currency (including coin) in circulation outside Federal Reserve Banks and the U.S. Treasury, plus deposits held by depository institutions at Federal Reserve Banks. These data are adjusted for the effects of changes in statutory reserve requirements on the quantity of base money held by depositories

http://research.stlouisfed.org/fred2/series/BASE/

[cubical]

What is in the monetary base? The monetary base is the amount of cash in the system combined with the amount of excess reserves banks keep with the Federal Reserve. If they aren't keeping lots of excess reserves (like they are now), the monetary base is lower. They currently have about $2 trillion in excess reserves. That is money not getting lent out. If they are making loans (such as during the housing bubble), they have fewer excess reserves and the monetary base is lower.

Total credit is over 50 trillion.



Now look at how little the monetary base has grown(up till 08) relative to credit.



If spending was really only limited to the monetary base, as you explain in your example, I find it hard to believe 50 trillion could exist in credit.

[TomtheTinker]

[cubical]

This is what I was speaking to about the banks getting the fed to cover any cash requests, as long as they had the loan as collateral on their books as one of their assets.

But it does not explain why 50 trillion in credit can exist on top of a 800 billion in monetary base. If the 9x rule was followed, it would mean total credit should peak at 7.2 trillion, but this is not even close. This could only happen if, in this example, the original 10 billion was withdrawn at the bank, and deposited elsewhere, creating a new 9x money creation. Or something along those lines.

[Zippyjuan]

The base is not a measure of bank deposits or lending potential- only excess deposits they chose not to lend out. It is also not a measure of money supply. The more they lend out (from those excess reserves), the smaller the monetary base gets because that lowers their excess reserves.

[cubical]

The base is not a measure of bank deposits or lending potential- only excess deposits they chose not to lend out. It is also not a measure of money supply. The more they lend out (from those excess reserves), the smaller the monetary base gets because that lowers their excess reserves.

Required reserves also count towards monetary base.

[Zippyjuan]

Correct. But the monetary base still does not necessarily reflect the amount of money available to the bank to lend out. They can also keep reserves in their own facilities to meet reserve requirements or to park excess reserves.

http://www.federalreserve.gov/moneta...reservereq.htm

Reserve requirements are the amount of funds that a depository institution must hold in reserve against specified deposit liabilities. Within limits specified by law, the Board of Governors has sole authority over changes in reserve requirements. Depository institutions must hold reserves in the form of vault cash or deposits with Federal Reserve Banks
.
The dollar amount of a depository institution's reserve requirement is determined by applying the reserve ratios specified in the Federal Reserve Board's Regulation D to an institution's reservable liabilities (see table of reserve requirements). Reservable liabilities consist of net transaction accounts, nonpersonal time deposits, and eurocurrency liabilities. Since December 27, 1990, nonpersonal time deposits and eurocurrency liabilities have had a reserve ratio of zero.

The reserve ratio on net transactions accounts depends on the amount of net transactions accounts at the depository institution. The Garn-St Germain Act of 1982 exempted the first $2 million of reservable liabilities from reserve requirements. This "exemption amount" is adjusted each year according to a formula specified by the act. The amount of net transaction accounts subject to a reserve requirement ratio of 3 percent was set under the Monetary Control Act of 1980 at $25 million. This "low-reserve tranche" is also adjusted each year (see table of low-reserve tranche amounts and exemption amounts since 1982). Net transaction accounts in excess of the low-reserve tranche are currently reservable at 10 percent.

Beginning October 2008, the Federal Reserve Banks will pay interest on required reserve balances and excess balances.

[cubical]

Correct. But the monetary base still does not necessarily reflect the amount of money available to the bank to lend out. They can also keep reserves in their own facilities to meet reserve requirements or to park excess reserves.

Are you saying the reserves in their own facilities are not part of the monetary base? That does not see right. Monetary base from Wiki:

Notes and coins (currency) in circulation (outside Federal Reserve Banks, and the vaults of depository institutions), Notes and coins (currency) in bank vaults, Federal Reserve Bank credit (minimum reserves and excess reserves)

So money held in vaults outside of the Fed still counts towards MB.

Imagine if the entire monetary base was require reserves(which isn't the case). The total credit outstanding would be 7.2 trillion(in 2008). Where does the extra 40+ tillion come from.

[Bohner]

Low inflation. There are basically three things which go into determining an interest rate. First is the desired rate of return the lender wants. They add on to that the expected rate of inflation during the time of the loan (so that the return is real- after inflation) and a premium based on the riskyness of the borrower (more likely to pay back the loan- lower premium). If the future inflation rate is uncertain, that adds the same as a higher rate of inflation would. Demand for money is factored in as well- if people aren't borrowing you may have to lower your rates to attract more customers. Inflation has been low so that has allowed interest rates to stay low.

We can kinda thank China for that- in two ways. First, all the cheap junk they sell us kept the price inflation rate low. Second, their demand for US Treasuries kept the prices for them higher and longer term interest rates (like those for mortgages) lower (Treasury note prices move inversely to the interest rates- higher prices due to higher demand means lower rates- and long term loans like mortgages tend to track longer term Treasury notes- mostly the fifteen year ones).

Again... Not possible. Especially for interest rates to remain low during recessions without printing money like crazy.

This pretty much sums it up.

[Zippyjuan]

Sums what up? The monetary base is not a measure of the money supply- if that is what you want to look at, M2 is the most commonly used measure. And for all the money the Fed has tried to put out there to cause price inflation, it has to be circulating. That means people earning or borrowing and spending it on goods and services. Prices rising becasue people are using more dollars to try to purchase goods. The POTENTIAL is out there due to the various Quantative Easing the Fed has done but it is not getting lent out and spent so far. That is known as velocity- and that is way down. It is also sometimes known as a money multiplier. If velocity picks up, prices likely will as well and as prices rise, interest rates will rise as well (that iflation portion of interest rates I mentioned earlier). The faster money moves through the system or the more often it changes hands, the greater the pressure on price inflation.

Velocity is a ratio of nominal GDP to a measure of the money supply. It can be thought of as the rate of turnover in the money supply--that is, the number of times one dollar is used to purchase final goods and services included in GDP.

http://research.stlouisfed.org/fred2.../M2V?cid=32242