I've been reading through this paper and found it fascinating, but have a few lingering questions which I can't quite reconcile.
The paper really stresses the point that banks are not reserve constrained in our current environment, and that central bank money (to be precise, M0) is not "multiplied up" into broad money (M2 for this purpose). The paper asserts broad money is created primarily by banks via loans (makes sense), and that this process is not constrained by reserves (doesn't make sense, to me at least).
Pg.16, ¶3: "In no way does the aggregate quantity of reserves directly constrain the amount of bank lending or deposit creation"
I don't understand this assertion. They then provide a very helpful graphic which walks through the balance sheet changes from the perspective of a buyer and seller's bank when a loan is made.
The customer takes out a loan, their bank increases both loans/deposits by the amount of the loan. Then the customer makes a purchase - so their bank reduces the customer's deposit on the liabilities side, and transfer's reserves on their assets side to the seller's bank. The buyer's bank must have reserves sufficient to facilitate this transaction, as discussed in the bottom right graphic.
How then, is the lending process (and corresponding broad money creation) not limited by reserves? Sure, a bank can create a loan and deposit pair, and assuming no regulatory reserve requirement, they can do this without needing any increase in reserves. However, when it comes time for the customer to withdraw that deposit and make a purchase, they absolutely need reserves. If they do not have sufficient reserves, they either need to borrow them, or they would be insolvent. If the banking sector in it's entirety had reserves less than the amount of the loan being created, how can this lending process continue?
The fact that M2 is about 3.93X M0 as of 2022-06-01 seems to indicate that clearly loans/deposits can easily exceed M0, but where does that difference come from? One explanation could be that deposits which are not associated with loans bring cash into the system, for example those brought in by savers.
Pg. 16 ¶4: "This description of money creation contrasts with the notion that banks can only lend out pre-existing money, outlined in the previous section."
Pg.15 ¶3 "One common misconception is that banks act simply as intermediaries, lending out the deposits that savers place with them."
The Bank of England thinks not!
Maybe they don't "lend out" deposits of savers, but without some form of deposits coming outside the loan creation process, how can there be enough cash to facilitate deposit withdraws associated with loans? Yes, not all customers withdraw their deposits at once, but when we are strictly talking about deposits created via loans, that is precisely what they do.
As a theoretical exercise - imagine a scenario in which the only deposits in the system were those created by loans. If M0 did not equal or exceed the system wide loan amount, no withdraws could occur from the deposits created from such loans. So the notion that "banks create money via loans" seems suspect to me. They create deposits, and yes deposits are M2 (money), but without M0 which loans don't impact, how is there not a hard limit?
Assume for examples sake a simplified banking system with 2 denovo institutions, where the M0 is fixed at \$500 prior to any loans being made, and the only deposits created come from loans. If Bank 1 makes a loan of \$500, then it creates a loan/deposit pair on it's balance sheet of \$500 each. Then the customer withdraws the deposit, placing it with bank 2 to make a purchase. Assuming bank 1 had those reserves, it then eliminates the deposit, and wires the reserves to bank 2. Bank 2 now has \$500 reserves and \$500 deposits, and Bank 1 has the loan and \$500 less reserves. Bank 1 can no longer create loans because it would not be able to honor the deposit withdraw associated with that loan, unless it borrowed \$500 reserves from Bank 1, which could then no longer lend for the same reason. The total amount of loans are constrained by the pre-existing reserves in the system.