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Comment by Kinnard | Hacker News Reader

Nope. This is how money is created by both central and commercial banks. When commercial banks do it it's a loan. When the Federal Reserve for example does it they are buying a government bond. Same process. Alas, if only people knew.

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If I borrow $100 from Bob (deposit), and turn around and immediately lend the same $100 to Charlie (loan), is that creating money? This is essentially what a commercial bank does, except on a much larger scale. If this is creating money, then anyone can create money, not just banks.

The Federal Reserve, on the other hand, can create money from nothing and use that to buy government bonds, like they did with QE.

Yes, you've increased the amount of money available to people to borrow (M2) by $100.

it affects inflation, if not as much as M0 does iirc. (its been a while since I've taken econ, so i'm a little fuzzy on that)

Yes, it would expand M2 money supply and affect inflation, but I don't think the scenario I painted was what Kinnard had in mind when he wrote "Banks don't actually borrow the money. They create it." To 'create money' under my scenario, you have to borrow it from someone else first.

You're not accounting for fractional reserve banking, where the banks only need to keep a certain amount of deposits on hand, and can loan the rest out to other people. For example, you deposit $100 into a bank. They keep, say, $20, and loan Erin $80 out to another person. This essentially creates money out of thin air since you still legally own that $100 dollars, and but now Erin has $80, bringing the total amount of money in our little economy to $180.

This all works fine assuming you don't try to withdraw all $100 since they only have $20 on hand. Nor would it be good if Erin defaults on her debt. Or the bank collapses. This is what FDIC is there to protect, where the government will create new money in case things collapse.

Indeed.

And what will Erin do with that money? She will give it to Tony in exchange for some service. What will Tony do? Pay that into his bank account. Which means the bank now has an extra $70 (assuming they keep a $10 reserve) that it can loan out, bringing the total amount of money in our economy to $250.

Also that $80 that Erin borrows will need to be paid back with interest. Say the interest is $20. She pays back $100. The bank now has $120. That $20 that she paid back had to come from somewhere. Say she sold a blanket she knitted to Paul to make that extra $20. Where did Paul get that money from? He had to borrow it from the bank. And the cycle continues...

> but now Erin has $80

Yeah but Erin had to put his house for getting his loan.

Buying assets (e.g. bonds) is one of the channels the Fed reserve uses to put new cash into circulation. Another channel is loaning the new money out, with interest, to private banks.

Private banks aren't creating money, the central bank is. You've confused the two.

The money that the central bank creates is central bank money/high-powered money/M0. The money that private banks create is the money in general circulation, i.e. M2. M2 is much bigger than M0.

M2 is derived from M0, which is created by the central banks. The person was clearly under the impression that private banks were creating M0.

I don't know. It's easy to over-interpret what somebody intended to say.

Which brings me to your own "M2 is derived from M0". There are certainly interpretations of that statement with which I would agree, but there are also interpretations which are seriously dubious. For example, the interpretation that "there is a causal mechanism from the quantity of M0 to the quantity of M2" is highly doubtful. The economists who actually study those things seem to come down mostly on the side of endogenous money, which says that the causality is the other way around: "changes in M2 drive changes in M0" - or rather, they did before interest rates went to the zero lower bound, at which point the two quantities became decoupled.

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