S&P to Inflation Hawks: The monetary system doesn’t work that way
Because that's not how it works. A change in the way the Fed and banks handle reserves in 2008 was missed by many and has caused a tremendous opportunity loss for those who've sat out the stock market recovery or have been blown up in commodity investments.
S&P's Chief Global Economist Paul Sheard tackles the topic in a new research report, combatively titled:
Repeat After Me: Banks Cannot And Do Not "Lend Out" Reserves
Highlights below:
Many talk as if banks can "lend out" their reserves, raising concerns that massive excess reserves created by QE could fuel runaway credit creation and inflation in the future. But banks cannot lend their reserves directly to commercial borrowers, so this concern is misplaced.
Banks do need to hold reserves (as a liquidity buffer) against their deposits, and banks create deposits when they lend. But normally banks are not reserve constrained, so excess reserves do not loosen a reserve constraint.
Banks in aggregate can reduce their reserves only to the extent that they initiate new lending and the bank deposits created as a result flow into the economy as new banknotes as the public demands more of them.
QE does aim to ease financial conditions and spur more bank lending than otherwise would have occurred, but the mechanisms by which this happens are much more subtle and indirect than commonly implied.
If the excess reserves created by QE were to be associated with too much credit creation, central banks could readily extinguish them.
If this sort of thing is your bag, read on:
Repeat After Me: Banks Cannot And Do Not "Lend Out" Reserves – PDF (S&P)
