Friedman never understood that under the gold standard, it is the price level which is fixed and the money supply that is endogenously determined, which is why much of the Monetary History ... is fundamentally misguided owing to its comprehensive misunderstanding of the monetary adjustment mechanism under a convertible standard."endogenously determined" - "produced or grown from within."
Banks and the Monetary Base (Wonkish) by KrugmanEndogenous money creation or destruction is the concept that each participant in the economy has their own version of a 'printing press' for money. This concept was explained by Irving Fisher in his treatise on The Theory of Interest (1930) in terms of the value of currency being affected by two (potentially opposing) movements - expected growth in the money supply reducing the real purchasing powerof money and expected increases in productivity increasing the real purchasing power of money.This means that participants can affect the value of currency in a number of ways:
- Investment choices to invest in 'non productive' money equivalents rather than to invest directly in productive assets effectively increases the money supply, reducing the real value of currency.
- Demands for higher wages or supplier payments can increase the financing requirements of firms, creating a risk of 'supplier led inflation', effectively reducing the real value of currency.
- Choices made about the level of contribution to productivity can increase the real value of currency, (in fact this is the only mechanism which provides any basis for the real value of currency.)This all adds up to the conclusion that participants have the power to affect the value of currency, albeit via less direct and potentially less effective mechanisms than simple printing of money by the central bank (exogenous money creation.)
Now, think about what happens when the Fed makes an open-market purchase of securities from banks. This unbalances the banks’ portfolio — they’re holding fewer securities and more reserve — and they will proceed to try to rebalance, buying more securities, and in the process will induce the public to hold both more currency and more deposits. That’s all that I mean when I say that the banks lend out the newly created reserves; you may consider this shorthand way of describing the process misleading, but I at least am not confused about the nature of the adjustment.
And the crucial thing is that there are no puzzles or misunderstandings here. Tobin and Brainard got it all straight half a century ago, and anyone who thinks that there’s a big flaw in their reasoning is almost surely just getting caught up in his own word games.Competition for loanable funds
To be able to provide home buyers and builders with the funds needed, banks must compete for deposits. The phenomenon of disintermediation had to dollars moving from savings accounts and into direct market instruments such as U.S. Department of Treasury obligations, agency securities, and corporate debt. One of the greatest factors in recent years in the movement of deposits was the tremendous growth of money market funds whose higher interest rates attracted consumer deposits.To compete for deposits, US savings institutions offer many different types of plans:
- Passbook or ordinary deposit accounts — permit any amount to be added to or withdrawn from the account at any time.
- NOW and Super NOW accounts — function like checking accounts but earn interest. A minimum balance may be required on Super NOW accounts.
- Money market accounts — carry a monthly limit of preauthorized transfers to other accounts or persons and may require a minimum or average balance.
- Certificate accounts — subject to loss of some or all interest on withdrawals before maturity.
- Notice accounts — the equivalent of certificate accounts with an indefinite term. Savers agree to notify the institution a specified time before withdrawal.
- Individual retirement accounts (IRAs) and Keogh plans — a form of retirement savings in which the funds deposited and interest earned are exempt from income tax until after withdrawal.
- Checking accounts — offered by some institutions under definite restrictions.
- All withdrawals and deposits are completely the sole decision and responsibility of the account owner unless the parent or guardian is required to do otherwise for legal reasons.
- Club accounts and other savings accounts — designed to help people save regularly to meet certain goals.