Monday, January 14, 2013

Nice to See Krugman nail something (if late)


This meant that the simple textbook description of how an open-market operation increases the money supply — a bank lends out 1-r of its new reserves (with r the reserve ratio), which return to the banking system, leading to another round of lending, and eventually the money supply rises by 1/r times the injection — is deeply misleading. What actually limits the growth in the money supply is the fact that a substantial part of each round of lending leaks out of the banking system, getting added to hoards of green paper bearing the faces of dead presidents.

This is the point about strategic money that I made back in 2002: the limiting factor is not specie (as it was a long time ago), nor assets (as it was under the "standard model" that Krugman alludes to) but the strategic balance of the monetary authority against those with the ability to hoard, not merely paper currency but other forms of liquidity. i.e. the people with the ability to execute a "walk on the bank."