Welcome to European Tribune. It's gone a bit quiet around here these days, but it's still going.
The ambiguity of multiple interpretations of money workings is by design, surely enough.

But the stated scenario does not give a full picture to me.

The bank knows that its overhead amounts to 1½ % of its portfolio

Seriously, is the overhead so practically proportional to the portfolio, or to the loan size? Would love to see how this proportionality works.

Having lent Bob money, the bank now has more liabilities that it needs to provide regulatory liquidity reserves for. It therefore goes to the interbank market to borrow the money at the central bank's policy rate.

But the CB loan only increases liabilities!

This liquidity ratio is not the same as fractional reserve ratio, right?

Does our bank has to borrow exactly the same amount from the CB as it lends to Bob? If not,

The bank looks up the central bank's policy rate, which turns out to be 2 %.

why does it add the full 2% to the costs, rather than a fraction of it?

And of course, if our bank has excess reserves, it has to borrow from the CB (even) less if at all. In a booming economy, the newly created money gets deposited in some bank, and liquidity reserves increase for virtually all banks, right? So there is hardly any need to borrow from the CB at those times, I guess.

Of course, things are very different when the credit market is collapsing and loans are underperforming. But then I see problems only in the assets/liabilities ratio, not in liquidity...

[The] central bank wants to suppress investments that would be profitable on their merits, in order to create enough spare capacity (read: Unemployment) in the economy to prevent inflation.

The implied wages/inflation "mechanism" is still not convincing to me. Certainly I don't see inflation following wages during a hyperinflation. If the problem is excessive money creation, then it is happening during a credit boom (like pre-2008). Why no one was crying about inflation then? At these times of desperate debt paybacks monitory obligations and volumes are actually being destroyed. How much does the CB "printing" offset decreasing M-volumes?

Then I have a problem with the assumption that the bank tries to balance it costs and profits like any other business. From what I could notice in post-Soviet transitions, banks were prospering well immediately, while they were basically just collecting liabilities (like saving accounts), not taking streams of asset returns yet. And then they get into problems when they should only enjoy asset returns?!!

Banking has more social impact than governing. Even if banks underperform as businesses, most of them are having better lunches than ever.

by das monde on Thu May 19th, 2011 at 06:46:58 AM EST

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