Banks are merely financial intermediaries that don’t use money as a medium of exchange for buying anything that contributes to GDP. If local banks save money at the central bank (the Fed in the US), it is merely the local bank lending to another bank. This is called bank reserves. Because banks never use their reserves to buy real goods and services, they are not money. Money is defined has being a medium of exchange, and bank reserves are never used as a medium of exchange.
Bank reserves are related to money in that reserves can be used to create real money, but reserves are not money any more than seed corn is food. Seeds are planted in order to multiply them and create food, but the seed corn is not food unless it is actually eaten rather than planted (or hoarded). Bank reserves are similar. If banks hoard reserves instead of using the reserves to create loans, then the hoarded reserves are called “excess reserves” because they are not being used. That is no more part of the money supply than stockpiles of unused seed corn is part of the food supply. The hoarding of excessive seed corn and the hoarding of bank reserves can both produce a kind of famine.
For example, Amartya Sen wrote a history of the Bengal famine of 1943, in which he claims that there was enough grain available to feed everyone, but that millions starved due to excessive hoarding of grain. When speculators started hoarding grain, they took it out of the markets which reduced the real supply and grain prices rose which made it too expensive for the poor to buy. As a result, two or three million people died. There is some dispute about how much grain hoarding was done by speculative Bengalis, but there is no dispute that there was plenty of grain in the world to feed Bengal and someone hoarded it away from the millions of dying Bengalis because it was not profitable enough to send it to them. Similarly, in the US and other developed nations, banking systems have been hoarding money in reserves since 2008. That hoarding has not been benefiting the unemployed capital and workers that were sitting idle in the aftermath of the Great Recession of 2008.
Bank reserves are often called “high-powered money” because it could be multiplied into large quantities of money if banks use their reserves to increase lending and get real money to real businesses and consumers. But “high-powered money” is a misnomer because it is not money. Bank reserves are never actually used to exchange goods and services and it is the goods and services that matter. It is just like seed corn can be multiplied into large amounts of food. But seed that is not multiplied into food has no power at all. Similarly, bank reserves can produce multiples of money if they are lent out to people who can use money, but the reserves themselves are never used just like seed corn is never eaten. If germination rates drop in half due to being stored too long, the power of seed-corn drops in half. Similarly the power of bank reserves solely depends upon whether it is used to make real money. The power of the monetary base (mostly bank reserves) is called its multiplier.
As you can see in the above graph, in 2008, the monetary base (red line) suddenly doubled in 2008. However, it’s power at creating money (M1 in green) simultaneously plummeted just as fast. The quantity of bank reserves doesn’t matter unless banks use them to create real money that can be spent on goods and services. Only real money matters because that is what is used to exchange of goods and services. The 2008 recession definitively demonstrated that reserves are not money. The FED pumped more money out to the banks, but they banks just hoarded the new money as excess reserves rather than letting the new money out into the economy where it could do some good to help feed people.
A better measure of the monetary base would exclude the excess reserves that are being hoarded in the bank vaults:
The blue line in the above graph shows the amount of bank reserves that have actually been used in the economy. The gap between the red line and the blue line is the vast amount of hoarding (excess reserves) at US banks. At the peak, almost twice as many bank reserves were being hoarded as were being used to influence the economy!
Numerous pundits have been warning about inflation because the Fed has quintupled the money supply since 2008 as the red line seems to show. These people have been predicting that this unprecedented increase in “high-powered money” will cause hyperinflation and chaos, but their fears are misplaced because they are not understanding the difference between unused seed corn that is hoarded (like excess reserves) and corn that is available for food (like money). The blue line shows the real change in the effective monetary base which is about the same as its growth during rest of US history.
The monetary base is not money and economists understood that when they created the main statistics for measuring money: M1, M2, M3, and MZM. These are our best attempts to measure the money supply and none of them include any money that is hoarded in bank vaults because this is never part of the money supply. Banks never directly use any of it for buying anything, so it isn’t really money and it doesn’t have any direct effect on the real economy.
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