# Why the increase in bank loans is not reflected in increasing money supply?

In the US banking system, according to what I was able to understand, the way to increase the money supply (MS) is via commercial banks loans ( I suppose it includes loans to the government but in any case something does not add up).

The money supply might also increase/decrease by the monetary policy such as QE or QT. it is reflected in the total assets of the Central Banks.

So, basically, I would expect to see that:

$$\Delta MS = \Delta loans + \Delta CBassets$$

However, when I look at the official data published by the Fed, I see that the $$\Delta MS$$ is smaller than expected (at least in the last 6 months): i.e., the increase in loans does not bring about enough increase in the MS. The difference is substantial of hundreds of Billions of $. In short, I don't see where the money created by the loan is going to? The series I was using: CB assets, Banks loans (we could also add the loans to the government but it won't change the question - still something is missing), Money Supply (we could also use M3 series but again it won't matter for this question). In this graph I would expect to see flat line, but it is not flat. • M2 does not include central bank asset so either the equation or data you are using are wrong – 1muflon1 Commented Oct 17, 2022 at 11:11 ## 1 Answer Your reasoning is not correct, there is no discrepancy to be explained here. First you are measuring money supply with M2. For M2: $$\Delta M2 \neq \Delta loans+ΔCBassets$$ Such equality simply does not hold. M2 is clearly defined (before and after 2020 respectively) as: Before May 2020, M2 consists of M1 plus (1) savings deposits (including money market deposit accounts); (2) small-denomination time deposits (time deposits in amounts of less than \$100,000) less individual retirement account (IRA) and Keogh balances at depository institutions; and (3) balances in retail money market funds (MMFs) less IRA and Keogh balances at MMFs.

Beginning May 2020, M2 consists of M1 plus (1) small-denomination time deposits (time deposits in amounts of less than \\$100,000) less IRA and Keogh balances at depository institutions; and (2) balances in retail MMFs less IRA and Keogh balances at MMFs. Seasonally adjusted M2 is constructed by summing savings deposits (before May 2020), small-denomination time deposits, and retail MMFs, each seasonally adjusted separately, and adding this result to seasonally adjusted M1.

So M2 is currently given by (the same holds also in $$\Delta$$-s):

$$M2= \text{small deposits} - \text{ IRA and Keogh balances} + \text{small-denomination time deposits} + \text{retail MMFs} +M1$$

Where $$M1$$ is clearly defined (before and after 2020 respectively) as:

Before May 2020, M1 consists of (1) currency outside the U.S. Treasury, Federal Reserve Banks, and the vaults of depository institutions; (2) demand deposits at commercial banks (excluding those amounts held by depository institutions, the U.S. government, and foreign banks and official institutions) less cash items in the process of collection and Federal Reserve float; and (3) other checkable deposits (OCDs), consisting of negotiable order of withdrawal, or NOW, and automatic transfer service, or ATS, accounts at depository institutions, share draft accounts at credit unions, and demand deposits at thrift institutions.

Beginning May 2020, M1 consists of (1) currency outside the U.S. Treasury, Federal Reserve Banks, and the vaults of depository institutions; (2) demand deposits at commercial banks (excluding those amounts held by depository institutions, the U.S. government, and foreign banks and official institutions) less cash items in the process of collection and Federal Reserve float; and (3) other liquid deposits, consisting of OCDs and savings deposits (including money market deposit accounts). Seasonally adjusted M1 is constructed by summing currency, demand deposits, and OCDs (before May 2020) or other liquid deposits (beginning May 2020), each seasonally adjusted separately.

Hence there simply is no discrepancy to explain. Your equation is not correct provided you want to measure money supply using M2. Also I know of no generally accepted theory or measure of money supply that would measure change in money supply $$\Delta M$$ as change in loans and CB assets.

• Thanks you very much for your answer. I probably could phrase my post better. I understand the definition of M2- but my question is what explains the movement of M2: in other words if M2 rises (say by more deposits), from where does the money come from to deposit more? I understand (and probably mistaken/missing a piece) that new money can come only from Fed injecting it by QE or by banks giving loans. However, as my question states, I don't see this relation holds well. Commented Oct 17, 2022 at 12:00
• @discipulus but 1 dollar of high powered central bank money can lead to multiple loans and deposits. Also every loan automatically also creates deposit since every time you get a loan bank also deposits money on your account. As I explained in last paragraph there is no theory (that is mechanism) endorsed by any economists that would say M2 change equal to change in CB money plus loans even if everything else is held constant
– 1muflon1
Commented Oct 17, 2022 at 12:15
• yes, but we have the figure of the total loans (after aggregation) - that's my point: as you say the deposits rise as a function of the loans. So M2 should rise a function of the loans. if we have total aggerate net of new 100B loans it should be reflected in loans figure and deposit (assuming no other institution) and hence in M2. But what we are seeing is that recently new loans did not translate into new deposits. that's what I'm asking. where did the money from the new loans go into? Commented Oct 17, 2022 at 12:26
• @discipulus but you need to account for all things that affect M2 to claim there is a discrepancy. How can you claim there is discrepancy just on account of loans if you ignore all other factors? That’s like leaving a tap open and not closing the sink and wondering why after measuring flow of water that would be sufficient to fill the sink the sink is empty. To claim that there is discrepancy in the numbers you need to account for all changes that happen at the same time
– 1muflon1
Commented Oct 17, 2022 at 13:08
• I agree. But I think of only two things that effect M2 as I said. If you know more please let me know and it might answer my question. again, I know M2 consists of multiple kind of deposits, MMF , etc - the thing is how they are created/destroyed. what accounts to their change. One can move money from depoist to physcal cash to MMF and vice verse. but M2 will always stays the same. Is there a way to move money out/into of M2 without loans and QE/QT? Commented Oct 17, 2022 at 13:18