Unlike our bemused conclusion about the idiocy of Rogoff’s latest pitch to do away with cash (something we predicted would happen years ago as banning cash is a necessary, if not sufficient, condition for NIRP to work), Green provides the following thought experiment to demonstrate just how ridiculous economic prescriptions have become:<\/p>\n
\n<\/div>\n<\/div>\n“Ken wants even more powerful monetary policy ability to pursue negative rates \u2013 because they are doing such a bang up job in Japan and Europe \u2013 or at least they would be if it weren\u2019t for that pesky reality of cash.\u00a0 Like many Keynesian proposals, however, this ridiculous love affair is predicated on a very simple concept \u2013 lower interest rates equals more borrowing and therefore economic growth.\u00a0 A simple thought experiment suffices to prove this fallacy.\u00a0 Imagine the government sets a -100% rate to \u201cstimulate\u201d growth.\u00a0 Almost immediately, all economic activity would cease.\u00a0 Payments would go unaccepted, checks would be refused, loanable funds would evaporate.\u00a0 Yes, there would be an initial burst of economic activity as \u201csavers\u201d fled from currency, but move to the second economic period\u2026 what happens next?\u00a0 Do banks lend money?\u00a0 They would like to\u2026 but who would take the electronic deposit that needed to be spent immediately with no one willing to accept it?\u00a0 It\u2019s an absurd scenario, but it illustrates the primary issue with negative rates \u2013 under a negative rate scenario, the only participant receiving more cash over time is the government<\/strong>.\u00a0 The private sector slowly collapses as we are seeing in Japan and Europe in real time.<\/strong><\/p><\/blockquote>\n
Green then confirms something else we have said for years, namely that “the Keynesian model of banking is simply wrong.”<\/p>\n
\n<\/div>\n<\/div>\nBanks are not constrained by either cash or reserves \u2013 both are easily available in ordinary times and in fact modern research into the credit creation process reveals that neither <\/strong>is viewed as a constraint.\u00a0 Using the equivalent of the medical technique of tagging radioactive isotopes for cancer research, Richard Werner presented empirical studies on this subject in 2014<\/p>\n
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This paper presents the first empirical evidence in the history of banking on the question of whether banks can create money out of nothing. The banking crisis has revived interest in this issue, but it had remained unsettled. Three hypotheses are recognised in the literature. According to the financial intermediation theory of banking, banks are merely intermediaries like other non-bank financial institutions, collecting deposits that are then lent out. According to the fractional reserve theory of banking, individual banks are mere financial intermediaries that cannot create money, but collectively they end up creating money through systemic interaction. A third theory maintains that each individual bank has the power to create money \u2018out of nothing\u2019 and does so when it extends credit (the credit creation theory of banking). The question which of the theories is correct has far-reaching implications for research and policy. Surprisingly, despite the longstanding controversy, until now no empirical study has tested the theories. This is the contribution of the present paper. An empirical test is conducted, whereby money is borrowed from a cooperating bank, while its internal records are being monitored, to establish whether in the process of making the loan available to the borrower, the bank transfers these funds from other accounts within or outside the bank, or whether they are newly created. This study establishes for the first time empirically that banks individually create money out of nothing<\/strong>. The money supply is created as \u2018fairy dust\u2019 produced by the banks individually, “out of thin air”.<\/em><\/p>\n
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