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This year’s Nobel – How absolutely gorgeous

So, Ritchie insists that banks just don’t need deposits. They just invent the money they lend. MMT explains all of this.

The more traditional view is that banks do need deposits. Because while they may invent money when they lend they must finance that by the close of play that day.

So, today’s Nobel (OK, Sveriges Riskbank in memory of etc):

For the economy to function, savings must be channelled to investments. However, there is a conflict here: savers want instant access to their money in case of unexpected outlays, while businesses and homeowners need to know they will not be forced to repay their loans prematurely. In their theory, Diamond and Dybvig show how banks offer an optimal solution to this problem. By acting as intermediaries that accept deposits from many savers, banks can allow depositors to access their money when they wish, while also offering long-term loans to borrowers.

However, their analysis also showed how the combination of these two activities makes banks vulnerable to rumours about their imminent collapse. If a large number of savers simultaneously run to the bank to withdraw their money, the rumour may become a self-fulfilling prophecy – a bank run occurs and the bank collapses. These dangerous dynamics can be prevented through the government providing deposit insurance and acting as a lender of last resort to banks.

Fractional Reserve Banking does that maturity transformation we desire, but leaves a structural fragility best solved by central bank lending against security but at high rates. Bagehot therefore.

The bit I’m looking forward to is what will the P³ say about this? That it’s all rubbish, MMT shows this is wrong, the Nobel? Say it’s only true because people ignore MMT? Or ignore the whole thing altogether?

This, by Timothy Taylor, is a very, very, good non-specialist explainer. No, really, it’s excellent. A potato could grasp that – even if not Spud.

Oh, there is one other little interest here. Why did the economy go pop? The simple explanation being rewarded with a Nobel what, one month after the woman who asked the question died?

11 thoughts on “This year’s Nobel – How absolutely gorgeous”

  1. For a moment there I thought the Diamond in the piece was Peter Diamond and was possibly the first double winner. No, this one is called Doug.

  2. So you get a Nobel prize now for pointing out something thats been known pretty much since FRB was invented? perhaps they should give Jimmy Stewart a posthumous Nobel too, as he explained the concept to the masses rather well in his 1946 film Its A Wonderful Life?

  3. At high rates? NOT?

    Why is the fractional reserve rate 0, meaning banks lend first then borrow reserves as needed just to make payments, no longer to satisfy regulations?

  4. @Bongo
    And I thought when the article mentioned Tim Taylor that ‘Tool Time’ had better economic advice than Ritchie.

  5. There’s no real satisfaction to be had, Spud is too thick to realise how wrong he is and Mentalist Monetary Theory is a cult, so immune to criticism.

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