Rethinking the Concept of Credit Creation and the Recent Policy of

the Bank of Japan

Akira Matsumoto(Ritsumeikan University)

9/26/2014 PK conference 2014Room302

Consequence of the Quantitative Easing Policy by the Bank of Japan

• The Bank of Japan has adopted the QE Policy like a super since 1999.

• This policy has been failed from the only view of money supply and getting out of deflation.

• The point is why the base money supply of the Bank of Japan hasn’t led to increasing of money supply and anti-deflation(or reflation)

0

200,000

400,000

600,000

800,000

1,000,000

1,200,000

1,400,000

1,600,000

Amount of Required Reserves Reserves

ExcessR

eserve

Amount of reserves (Average Outstanding/ Million

-30

-20

-10

0

10

20

30

40

50

60

Jan-98 Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14

M2 BaseMoney

Base Money and Money Supply(relative change from last year)

(%)

90

95

100

105

110

115

CorpratePriceIndex CPI

Price Index 1998-2014 (2010=100)

Why Credit Creation?

• Is the Starting point of Money Supply the base money (that is the central bank)?

• Is Money Supply the result of financial intermediating process by base money supply?

• The Japanese experience since 1999 gives us the above questions

• The Approach to the answer is how the credit creation as the process of money supply should be considered.

What does Bank do?• Deposit is IOUs like a bank bill as everybody know.

• It circulate as a method of payment. Moreover any cash doesn’t back them (or back a part of deposits).

• If IOUs without any backing can be accepted as a means of payment, Banks don’t need to correct any cash in order to make a loan. As deposits (or balance of account) are means of payment, Borrowers don’t need any cash in making the loan actually.

• We can reach to answer here. →To lend IOUs without any backing is ‘Credit Creation’

Conditions to lend IOUs without baking

(First)

• IOUs are debt. Therefore, as long as there is not even a demand of the return, it continues to circulate as means of payment. In the case of bank if any transaction persist in clearing in their account, deposit aren’t withdrawn as needed by the depositor (that is, no demand of the repayment). In their account, deposit as a debt keep itself as a cash.

(a principal of the offset of debt and credit)

Conditions to lend IOUs without baking

(Second)

• Deposit is born by a loan, and disappeared by the return.

• As long as deposit is a capital for banks and social reproductive process is subject to capital, deposit is lent as capital. Therefore the return depend on a back flow of capital. Investment is an advance of capital, the collect of it is a back flow of capital.

• Capital should be lent in advance (investment) and reflex to the start point (capitalist=investor).

Credit Creation is NOT a creation of the existence from nothing

• The Process of the advance and flow back of capital is the process of producing value by labor working and realizing one.

• In this means, credit creation as lending capital is a lending on expecting values which will be produced in the future.

• Credit Creation is to make credit a interest-bearing capital.

Real economy and credit creation• As long as credit creation should take the future value in advance, possibility and limitation of credit creation depends on both capital flow back, that is, a satisfactory movement of reproduction and the offset of debt and credit.

• In this point the reproduction process of value (the real economy) underlies the credit creation

• Therefore excess credit creation over needs of the real economy strongly leads fictitious and excess demands(a kind of bubble, this is not a subject here).

Central bank and commercial bank

• As I mentioned above, by the credit creation which is started by responding the demand for fund of the real economy, commercial banks are immediately faced with a withdrawal from their account in cash or sending to other banks.

• At this time commercial bank need a final means of settlement (a finality). That is the reserve, that is the current deposit on the central bank.

• The reserve is IOUs for the central bank.

The reserve resulted from credit creation by the central bank

• Commercial Bank call for the reserve to the central bank. The central bank should meet this demand by banking services like as commercial bank in credit creation.

• Trust of the central bank supports trusts of commercial banks.

• In sum, the process of money supply is the process which starts at lending of commercial banks and completes at lending of the central bank.

Base money supply is passive

• As the supply of reserves is banking service with interest (the Bank Rate) for the central bank, the reserve is a kind of cost for commercial banks. Therefore they does never demand any reserves at all, unless any necessities of fundraising occur. That is, they don’t have any excess reserve. Excess reserves is called “Buta-dumi” in Japanese ( a futile deposit).

• No demand of money in the real economy, no supply of any base money

Unreasonableness Effort by the Bank of Japan

• In order to keep the target of reserve

– The current account of the BoJ with interest

– No return operation of the long term government bond

– To purchase the private asset (ex. ETF , J-REIT and so on)

• Deterioration of the composition of its assets

Composition of BoJ Assets

1980 1990 2000 2005 2011 2014# Gold Bullion 1,404 1,404 4,445 4,412 4,412 4,412

# Money 935 4,314 2,344 1,927 3,371 2,728

# bill bought 32,000 69,056 75,836 440,899 0 0

# Government Bond

158,351 315,421 562,943 989,175 1,050,687 2,082,258

- T-bill 116,309 225,410 160,953 51,306‒ -

Commercial Paper etc. ‒ ‒ ‒ ‒ 14,101 20,414

Corporate Debenture ‒ ‒ ‒ ‒ 28,925 33,618

Money trust(Stock) ‒ ‒ ‒ ‒ 14,100 13,515

Money Trust(ETFs) ‒ ‒ ‒ ‒ 14,382 29,566

Money Trust(J-REITs) ‒ ‒ ‒ ‒ 1,041 1,496

Discount bill 2269 1437 48 0 0

loan 21020 61595 6887 0 334,531 248,531

Deposit Insurance corporation(DIC) loan ‒ - 1339 0

# Foreign Exchange 21,893 29,960 36,856 47,278 48,366 54,224

# Agents balance 5 714 1445 107 407 76

# Repo security deposit - - 183777-

# others 2847 7663 12095 6716 4,434 5,476

Total(asset, liability and capita)

241,045 491,566 1,067,9621,556,071

1,518,756 2,498,514

Changing of Asset Scale（Index, 1980＝100）100 204 443 646 630 1037

（100million Yen）

Conclusion for now: Dialectical process of nontraditional

monetary policy of the BoJ• The direct purpose of a super and long term QE

policy of the BoJ has changed from increasing money supply to keep the yield curve zero and flat.

• The BoJ has thrown its independence away and gotten a financial institution for government (irony of QE policy)

• what is the final point (an end) → Hyper inflation?