No doubt some olden-times banks did what you said, lending the same gold or cash multiple times as paper IOUs but that's an example of non-reserve banking (and total illegal in modern countries these days). That's not fractional-reserve banking.(the quotes,as in who said what, are off because of the change to the new system)QuoteOriginally posted by: daveangelQuoteOriginally posted by: Traden4AlphaLooks like Iceland intends to end boom and bust cycles through MORE central bank power.that story ought to go in the Bad Reporting thread...How so? This is the first I've heard of this story so if the reporting is wrong......
this is the way fractional reserve banking creates money.
In olden times when gold was money and people left their gold at a bank for safe keeping, the bank would give them a receipt. And then lend the customer's gold to someone else. If they lent the actual gold, they could only lend it once, until someone redeposited the gold. But if the borrower was given a receipt for the gold instead of the actual gold, the bank could lend that gold out a whole bunch of times. Until they got a run on the bank when everyone presented receipts at the same time and demanded the gold
With checkbook money, something similar happens. I deposit $1000 at a bank and the bank lends it out. Except they don't give the borrower $1000 in cash, they give them a check, or an electronic entry in their account, and no actual physical money changes hands. If the reserve requirement is 10%, then if I deposit $1000, the bank can create another $9000 in checkbook money and lend it to borrowers, so that they have $10,000 in people's accounts and $1,000 in reserves.
T4A used to tell a story about how the bank would lend out 90% of the $1000, which was then redeposited, and then the bank would lend out 90% of the 90%, and then 90% of the 90% of the 90% and so on, which would add up to $9000. But they would only needed to do that if they were giving out actual cash rather than checkbook money.
If commercial banks can no longer create money, you first need to decide how you define money. M0,M1,M2, or M3? or something else.If "money" is defined as M3 and includes both demand deposits (like a checking account or a passbook savings account that doesn't require notice) and time deposits, then the Icelandic banks would be unable to lend money, period, because to do so would create money.Definition of M0, M1, M2, M3, M4
Different measures of money supply. Not all of them are widely used and the exact classifications depend on the country. M0 and M1, also called narrow money, normally include coins and notes in circulation and other money equivalents that are easily convertible into cash. M2 includes M1 plus short-term time deposits in banks and 24-hour money market funds. M3 includes M2 plus longer-term time deposits and money market funds with more than 24-hour maturity. The exact definitions of the three measures depend on the country. M4 includes M3 plus other deposits. The term broad money is used to describe M2, M3 or M4, depending on the local practice.
If a narrower definition is used, such as M0/M1, then the banks could lend money in time deposits but not demand deposits, and could do so only once.
If Iceland is going down this road, they obviously believe that creating money leads to boom-bust cycles
In fractional reserve banking, the total amount of loans is ALWAYS less than the total amount of deposits. The difference between loans-deposits is the reserve.
Fractional reserve does seem to make money out of thin air. Moreover, it can do so even in a true gold-standard, specie-money economy.
For example: If Joe deposits 100 physical gold coins in a bank, Joe still thinks he has 100 gold coins that he might be able to spend. Sure, he'll need to withdraw each coin he wants to spend before he can spend it but from his perspective he still owns 100 coins.
Next, if the bank lends 90 of those physical coins to Jane, Jane now has 90 coins that she might be able to spend.
Between the two of them it seems Joe has 100 coins and Jane has 90 coins so there's now 190 coins in the economy (M2 money). Meanwhile, the bank has 10 physical coins, an IOU from Jane in which she promises to repay 90 coins plus interest at a later date, and the bank has a liability of 100 coins that it owes to Joe.
Everything is fine, especially if Jane redeposits the 90 physical coins or if Jane buys something with the 90 physical coins and the customer deposits the coins for safe keeping.
It's only if Joe demands more than 10 coins before Jane (or Jane's customer) deposits the loaned coins that things get messy. That is, fluctuations in the consumer side of M0 relative to bank's reserves on M2 need to be small enough so there's never a transient in demands to withdraw specie that exceed the sum of recent deposits of specie and reserves of specie in the bank.
A more realistic model would have Joe keep 10 coins for daily spending, Joe deposits 90, the bank holds 9 of Joe's coins in reserve, the bank lends 81 coins to Jane, Jane holds 8 coins for daily spending, Jane redeposits 73 coins in the bank, the bank holds 7 of Jane's coins in reserve, the bank lens 66 coins to Jack, Jack keeps 7 coins fs for daily spending, Jack deposits ..... If you crank out the math, you find that about 50 of the original 100 coins are sitting in consumer pockets (about half of M0), the other 50 are sitting in the bank (reserves being other other half of M0). But if you ask consumers how much money they have the answer is 500 coins (M2 money).
At no time did the bank ever give out more than it had on hand. M0 remains fixed to the 100 physical gold coins but M2 grows in inverse proportion to the percentage of coins that both consumers and banks keep as reserves for daily needs.
To a first approximation it would seem that the bank's required fraction of reserves would depend on the level of risk. The greater the chance of borrower default, the greater the reserves the bank should keep to ensure it always can satisfy depositors demands. This seems to lead to a reserve fraction policy that decreases the fraction with low-risk borrowers (and stable times) and increases it with higher-risk borrowers (and unstable time). But the second order effects of reserve fraction on M2 (and higher forms of money) all but guarantee that this reserves-are-proportional-to-risk policy will drive booms and busts unless there is some other strongly countercyclical regulation of the money supply (i.e., a central bank).