Deficit Owls | 'Loanable Funds' and 'Crowding Out' Don't Exist @deficitowls5296 | Uploaded September 2017 | Updated October 2024, 3 hours ago.
Professor Bill Mitchell discussing the functioning of the banking system. Neoclassical models of "loanable funds" and "crowding out" are simply wrong. These things just do not exist.
The typical story goes that there is a fixed supply of funds available for investment, "loanable funds," and the price of borrowing, the interest rate, is set by supply and demand in this market. Furthermore, when the government runs deficits, because it is borrowing to raise funds to spend above what it collects in taxes, this puts pressure on the supply of loanable funds, raising interest rates, and taking away funds that would otherwise be available for private investment.
Fortunately, every part of this story is false. As is increasingly acknowledged even by the mainstream, banks do not take money from savers and lend it to borrowers. In fact, banks create money every time they make a loan, hence the short-hand "loans create deposits," and they are not constrained in their capacity to make loans by reserve requirements or anything else, except the availability of creditworthy loan applicants.
This means that there is no such thing as a fixed supply of funds available. Instead, the monetary system is elastic: when the funds for investment are needed, they are loaned into existence; when the investment is complete and the debt repaid, the funds disappear, destroyed.
Furthermore, we must look more closely at government spending. Government bonds, which the government issues when it "borrows," can only be purchased using government currency, which can only come into the hands of the private sector from government spending or government borrowing (unlike bank money, which is created by banks making loans). This means that as a matter of logic, government spending must come BEFORE government "borrowing": the government creates the money it's spending from thin air, and then borrows it back afterwards.
So in fact, not only is it not true that government deficits raise interest rates, from inception the opposite is true: when a government check clears, this adds to the monetary base held by the private sector, which all else equal will LOWER interest rates, potentially to zero. Then, to avoid this outcome, the government sells a bond, "borrowing" back its currency, draining excess reserves. So we see that the (overnight) interest rate gets set wherever the government wants (and long term rates follow closely) and there is no possibility of "crowding out."
Watch the whole video here: youtu.be/MLKrBsTQntA
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Professor Bill Mitchell discussing the functioning of the banking system. Neoclassical models of "loanable funds" and "crowding out" are simply wrong. These things just do not exist.
The typical story goes that there is a fixed supply of funds available for investment, "loanable funds," and the price of borrowing, the interest rate, is set by supply and demand in this market. Furthermore, when the government runs deficits, because it is borrowing to raise funds to spend above what it collects in taxes, this puts pressure on the supply of loanable funds, raising interest rates, and taking away funds that would otherwise be available for private investment.
Fortunately, every part of this story is false. As is increasingly acknowledged even by the mainstream, banks do not take money from savers and lend it to borrowers. In fact, banks create money every time they make a loan, hence the short-hand "loans create deposits," and they are not constrained in their capacity to make loans by reserve requirements or anything else, except the availability of creditworthy loan applicants.
This means that there is no such thing as a fixed supply of funds available. Instead, the monetary system is elastic: when the funds for investment are needed, they are loaned into existence; when the investment is complete and the debt repaid, the funds disappear, destroyed.
Furthermore, we must look more closely at government spending. Government bonds, which the government issues when it "borrows," can only be purchased using government currency, which can only come into the hands of the private sector from government spending or government borrowing (unlike bank money, which is created by banks making loans). This means that as a matter of logic, government spending must come BEFORE government "borrowing": the government creates the money it's spending from thin air, and then borrows it back afterwards.
So in fact, not only is it not true that government deficits raise interest rates, from inception the opposite is true: when a government check clears, this adds to the monetary base held by the private sector, which all else equal will LOWER interest rates, potentially to zero. Then, to avoid this outcome, the government sells a bond, "borrowing" back its currency, draining excess reserves. So we see that the (overnight) interest rate gets set wherever the government wants (and long term rates follow closely) and there is no possibility of "crowding out."
Watch the whole video here: youtu.be/MLKrBsTQntA
Follow Deficit Owls on Facebook and Twitter:
facebook.com/DeficitOwls
twitter.com/DeficitOwls
And follow our sister page, Modern Money Memes:
facebook.com/ModernMoneyMeme
twitter.com/ModernMoneyMeme
