banks: rich lenders and poor borrowers

Banks and macroeconomic models by Steve Randy Waldman

Suppose, for example, that banks lend primarily to cash-starved agents, and that cash-starved agents spend primarily to cash-rich agents. (I am including bank deposits as in my definition of “cash” here.) Should the banking system “exogenously” increase lending, the effect would be first a transfer of cash and an increase in debt to the cash-poor, and then a transfer of cash to the cash-rich as borrowers spent their loans. Suppose that the cash-rich then find themselves holding more bank deposits then they prefer to hold. Mechanically, they have absolutely no ability to redeem the deposits for other assets. The only way that deposits in aggregate are reduced is when loans are repaid to the banking system. But the cash-rich have very few loans to repay! Unless they pay off the loans of the cash-poor, taking losses to uphold the collective preferences of a putative nonbank private sector, bank deposits are as inescapable to cash-rich as base money is to the private sector as a whole. 

If the real world looks anything like this, then commercial banks do indeed have something quite analogous to a central bank’s printing press. Net-expansions of the banking system’s balance sheet provoke an inescapable injection of deposits into the aggregate portfolio of the cash-rich. The price of bank deposits, like base money, is pegged to unity. If deposit balances come to exceed the desired allocation in portfolios of the cash-rich, the imbalance cannot be resolved by falling prices. Instead, a “hot potato” effect must take hold: prices of other assets might be bid higher until deposits are restored to their desired small share of the aggregate portfolio. Credit expansion would lead to asset price inflation (much more than to ordinary price inflation, as the consumption plans of the cash-rich need not change in real terms, so there is no impetus to bid up the prices of goods, services, or labor). As a stylized fact about the world, bank-credit-expansion-leads-to-asset-price inflation seems pretty solid.

I don't fully understand the terms and concepts of the discussion but I wonder if Waldman is ignoring the difference between full employment and depressed economies.