<p>M3 isn't even published anymore in the US (it did not include bonds though).</p>
<p>As Alex noted, the LCR is entirely unaffected if the FED purchases government bonds because both are level 1. See for example this <a href="https://www.google.com/url?sa=t&amp;source=web&amp;rct=j&amp;url=https://www.bis.org/publ/qtrpdf/r_qt1212g.pdf&amp;ved=2ahUKEwjXiYCB7Lf5AhXAYPEDHX1lAkgQFnoECA8QAQ&amp;usg=AOvVaw2c0uqFq3624W07Ups0mj1A" rel="nofollow noreferrer">BIS paper</a> on P.58 for a simple example demonstrating this.</p>
<p>Moreover,
the Fed cannot control the federal funds</p>
<blockquote>
<p>rate through routine changes in the quantity of reserves, also known
as open market operations (OMO)</p>
</blockquote>
<p>as copy pasted from <a href="https://www.federalreserve.gov/econres/notes/feds-notes/implementing-monetary-policy-in-an-ample-reserves-regime-the-basics-note-1-of-3-20200701.htm" rel="nofollow noreferrer">this FED note about the ample reserves regime</a>. This is a direct effect of the ample reserves regime, where the <a href="https://www.federalreserve.gov/monetarypolicy/reservereq.htm#:%7E:text=As%20announced%20on%20March%2015,requirements%20for%20all%20depository%20institutions" rel="nofollow noreferrer">reserve requirement ratio is zero</a>.</p>
<p>Generally, OMO can mean a lot of things (purchase of all sorts of securities) but (ignoring the title), I think the main argument is about the purchase of government bonds? For short, this does neither affect the interest rate (in an ample reserves regime), nor the liquidity ratio (LCR) / capital requirement of a bank. The latter statement requires that the central bank is purchasing a highly liquid (level 1) asset though (which US government bonds are).</p>
<p>Insofar, as written in your post, a purchase of government bonds by the FED has</p>
<blockquote>
<p>no direct impact on credit creation,</p>
</blockquote>
<p>at least not via the LCR or interest rate channel. I am inclined to believe that this was the argument made by whoever you heard this from. I am less convinced they mentioned money supply because traditionally the monetary base is defined as currency in circulation plus reserve balances and while there are more liquid types, none include bonds in the US in any case (there used to be M4 and L which included T-bills but these were stopped long ago).</p>
<p>Lastly, the implementation of monetary policy has evolved considerably and repeatedly since the financial crisis. The FED also does not (anymore) target monetary aggregates when conducting monetary policy. I believe reading <a href="https://economics.stackexchange.com/a/49858/40033">this answer</a> might be interesting, although many others have different opinions about this subject.</p>
<p><strong>Edit</strong></p>
<p>Commercial bank credit is NOT part of M1. When a bank provides a loan,  the borrower receives a deposit. From the perspective of commercial banks balance sheets, this increases credits on the assets side and customer deposits on the liabilities side. Most of the times (with mortgages it is frequently directly sent to seller of the house / or mortgage notary's account) this deposit is withdrawn quickly and usually sent to another bank (unless the seller's bank account is at the same bank as the buyer's). Therefore, an individual commercial bank cannot generate lasting increases in its deposits by granting loans.</p>
<p>However, the banking system as a whole does see an increase in deposits (thus money supply) despite constant amounts of central bank money. Leaving potential reserve requirements aside, the bank will still have risk/return considerations to take into account when providing loans. From an asset liability management perspective, loans are long-term claims on the assets side, while sight deposits are typically liquid and short-term liabilities. In essence, that is one of the main reasons justifying commercial banking - it's an intermediary that brings together investors and savers despite their diverging requirements. Banks can offer this service because they can diversify the credit and liquidity risks better than individuals.</p>
<p>For risk management, banks need to consider factors such as current and future
interest rate on loans and deposits, the likelihood of deposit withdrawals and credit defaults and the like. On top of this, banks are tightly regulated. Banks need to follow the standards of Basel III, which consist of 3 Pillars</p>
<ul>
<li>Pillar 1: Capital requirements (<a href="https://en.wikipedia.org/wiki/Capital_adequacy_ratio" rel="nofollow noreferrer">Capital Ratio</a>, <a href="https://en.wikipedia.org/wiki/Basel_III#Leverage_ratio" rel="nofollow noreferrer">Leverage Ratio</a>,..), Credit risk, Market risk, <a href="https://en.wikipedia.org/wiki/Operational_risk" rel="nofollow noreferrer">Operational Risk</a> as well as <a href="https://www.ecb.europa.eu/pub/financial-stability/macroprudential-bulletin/html/ecb.mpbu201910_2%7E3237802727.en.html" rel="nofollow noreferrer">LCR &amp; NSFR</a>.</li>
<li>Pillar 2: mainly supervision like the Supervisory Review Evaluation Process (<a href="https://www.bankingsupervision.europa.eu/banking/srep/html/index.en.html#:%7E:text=This%20activity%20is%20called%20the,supervisory%20measures%20to%20be%20taken." rel="nofollow noreferrer">SREP</a>, <a href="https://www.eba.europa.eu/guidelines-on-icaap-and-ilaap-information" rel="nofollow noreferrer">ICAAP &amp; ILAAP</a>,...</li>
<li>Pillar 3: ...</li>
</ul>
<p>Long story short, banks cannot simply give away loans without end. Also, credit creation by banks relies on a lot more details than the traditional reserve requirement (money multiplier) argument suggests. Specifically, it is not just the consideration of outflows (of deposits) and inflows being spread over time and normally only being a fraction of total deposits (which is where the name <em>fractional reserve banking</em> originated, as only a fraction of customer deposits have to be covered all the time). Since deposits created by the banking
system belong to the banks’ customers, the main driving force behind credit creation are customers, not banks themselves.</p>
<p>In fact, the FED does not even aim to affect the broad money supply. St.Louis FED research claims it's best to forget what we learnt about money aggregates in <a href="https://research.stlouisfed.org/publications/page1-econ/2021/09/17/teaching-the-linkage-between-banks-and-the-fed-r-i-p-money-multiplier" rel="nofollow noreferrer">undergrad Econ</a>. The so called <em>dual-mandate</em> aims to (somewhat interestingly) promote three (not two) goals: maximum employment, stable prices, and moderate long-term interest rates</p>
<p>Neither of these goals mentions money supply. Also, <a href="https://www.newyorkfed.org/aboutthefed/fedpoint/fed49.html" rel="nofollow noreferrer">New York FED -
Money Supply</a> states that</p>
<blockquote>
<p>In 2000, when the Humphrey-Hawkins legislation requiring the Fed to
set target ranges for money supply growth expired, the Fed announced
that it was no longer setting such targets, because money supply
growth does not provide a useful benchmark for the conduct of monetary policy.</p>
</blockquote>
<p>and <a href="https://www.federalreserve.gov/faqs/money_12845.htm" rel="nofollow noreferrer">FED - what is money supply</a> claims that</p>
<blockquote>
<p>Over recent decades, however, the relationships between various
measures of the money supply and variables such as GDP growth and
inflation in the United States have been quite unstable. As a result,
the importance of the money supply as a guide for the conduct of
monetary policy in the United States has diminished over time</p>
</blockquote>
<p><a href="https://economics.stackexchange.com/a/49858/40033">This answer</a> has a few charts illustrating that total money supply is not really directly impacted by monetary policy. For example, normalizing each series to Dec 2005 = 100 (monetary base - <a href="https://fred.stlouisfed.org/series/BOGMBASE" rel="nofollow noreferrer">BOGMBASE</a>, <a href="https://fred.stlouisfed.org/series/WM1NS" rel="nofollow noreferrer">M1</a> - be careful, the definition changed in May 2020 if you look at the data on FRED, <a href="https://fred.stlouisfed.org/series/WM2NS" rel="nofollow noreferrer">M2</a>), the data looks like this (the code to replicate this is in the link: QE stands for quantitative easing)</p>
<p><a href="https://i.sstatic.net/muKZf.png" rel="nofollow noreferrer"><img src="https://i.sstatic.net/muKZf.png" alt="enter image description here" /></a></p>
<p>The dual-mandate got its name from employment and the price level, because under <a href="https://en.wikipedia.org/wiki/Full_employment" rel="nofollow noreferrer">full employment</a> (not no unemployment), and stable prices, interest rates settle at moderate levels. For details, you can read <a href="https://www.federalreserve.gov/newsevents/speech/mishkin20070410a.htm" rel="nofollow noreferrer">Frederic S. Mishkin (2007) speech at Bridgewater College</a>.</p>
<p>To summarize, the main goals of the FED are to keep prices stable and to promote full employment (closely related to a healthy economy / GDP). However, as just seen, there is only a weak relationship between measures of the money supply and GDP growth and inflation. Therefore, the central bank focuses on interest rates, not only the FED Funds market, but also longer term interest rates. Changing interest rates has a direct impact on demand for credit (by customers) and the risk metrics of banks (current and future interest rate on loans and deposits, the likelihood of deposit withdrawals and credit defaults, Basel III calculations, ...).</p>
<p>As written above, monetary policy has evolved considerably. For example, in the EUR area, so called Targeted longer-term refinancing operations (TLTROs) aim to offer commercial banks attractive long-term funding conditions. To stimulate lending to the real economy, the interest rate is negative and in a nutshell, the more loans participating banks issue to non-financial corporations and households (except loans to households for house purchases), the more attractive (the more negative) the interest rate. While ultimately there needs to be demand from customers, these favourable funding conditions make it easier (cheaper) to offer loans.</p>

CC BY-SA 4.0
2022-08-08T19:53:44.203Z
Thanks lots of great resources here -- the stuff on the ample reserve regime is particularly enlightening and puts a name to something i wondered about for a while (namely, how can changes in total bank reserves really matter when banks are already sitting on massive excess reserves?).  I'm a little confused where you come down though.  It seems like you agree that there's "no direct impact on credit creation" but not that there's no effect on the money supply.  When I said "money supply" in my post i wasn't referring to the monetary  base (continued...)
Mr. Cooperman
CC BY-SA 4.0
2022-08-08T20:01:02.420Z
The monetary base obviously increases with the creation of new reserves when the fed buys assets like govt bonds from commercial banks.  By "money supply" i meant a measure like M1, i.e. something like cash and coins plus commercial bank credit.  So if the fed's bond purchases don't expand commercial bank credit I don't see how they can affect the money supply.
Mr. Cooperman
CC BY-SA 4.0
2022-08-08T23:33:41.493Z
Thanks so much again for the added info.  The only remark I have is when you say "Commercial bank credit is NOT part of M1" I think you and I must be using the word "credit" in different ways.  All I mean by "credit" is electronic deposits at commercial banks -- ie what's in my checking account right now.  Surely that is part of M1, right?  Probably I am just misusing the word "credit".  Although i'm not sure what "commercial bank credit" *would* refer to if not these deposits.
Mr. Cooperman
CC BY-SA 4.0
2022-08-09T00:04:16.280Z
[Commercial bank credit](https://fred.stlouisfed.org/series/TOTBKCR) is an asset of banks, whereas deposits are liabilities. Bank credit is the first entry on the asset side, and deposits are the first entry on the liability side of the [Assets and Liabilities of Commercial Banks in the United States - H.8](https://www.federalreserve.gov/releases/h8/20220729/).  Frequently credit and loans are used interchangeable to refer to financing, but strictly speaking these are [distinct types of financing](https://www.bancosantander.es/en/faqs/particulares/prestamos/diferencias-prestamo-credito).
AKdemy
CC BY-SA 4.0
2022-08-09T00:14:13.610Z
A checking account derives its name from the standard method of making a withdrawal, which was by writing a cheque. While this method is a bit archaic, the name checking account still exists and is essentially the same as a current account or deposit account (a type of account that accepts deposits, where you can withdraw in a number of ways - cheque, debit card, ATM machine etc.). Either way, they are liabilities for banks (as long as there is a positive sum on the account).
AKdemy
CC BY-SA 4.0
2022-08-09T01:01:37.843Z
ah so "bank credit = bank deposits" isn't even an accounting identity?  so i really need to start saying "deposits" instead of "credit".
Mr. Cooperman
CC BY-SA 4.0
2022-08-09T01:03:28.760Z
i think what created the confusion is i hear so much talk about "credit creation" which i take to mean the creation of new deposits when banks make loans. but it sounds like youre saying "credit" in that phrase is really referring to the loan, not the deposit.
Mr. Cooperman
CC BY-SA 4.0
2022-08-08T19:15:39.137Z
2022-08-08T23:02:46.260Z
2022-08-08T23:02:46.260Z
AKdemy
<p>OMOs do increase money supply. When central bank conducts OMOs it does not use pre-existing money in the economy, it creates new money to conduct OMOs. OMOs would also increase money supply even without existence of private bank.</p>
<blockquote>
<p>When the fed buys or sells treasury bonds they are not changing the broader stock of highly liquid assets that include treasury bonds (is that m3?)</p>
</blockquote>
<p>US bonds are generally not M3 because average maturity of US bonds is 65 months (see <a href="https://www.pgpf.org/blog/2021/01/how-does-the-treasury-issue-debt#:%7E:text=More%20recently%2C%20average%20maturity%20has,24%20percent%2C%20while%20the%20share" rel="nofollow noreferrer">Peterson Foundation</a>) and M3 includes only debt securities with maturity less than 2 years (see <a href="https://data.oecd.org/money/broad-money-m3.htm#:%7E:text=Broad%20money%20(M3)%20includes%20currency,securities%20up%20to%20two%20years." rel="nofollow noreferrer">OECD</a>). In any case even if you would count all bonds in your preferred measure of money supply the bond would still exist and new cash that previously not existed was created so the measure of money supply would still increase.  When central bank buys bonds it does not automatically destroy them the way it automatically destroys cash when it sells bonds.</p>
<blockquote>
<p>Since there are no reserve requirements for commercial banks -- only capital requirements -- this doesn't actually affect the rate of credit creation since a bank that exchanges a dollar of central bank reserves for a dollar of us treasury debt is just as well capitalized as it was before.</p>
</blockquote>
<p>No this is actually not true. The new capital requirements depend on type of debt banks are holding. Banks generally need less capital for government bonds then private loans under Basel III.</p>
<p>Moreover, the term 'capital requirements' is somewhat misleading. Capital requirements under Basel III also specify that banks have to have some level of liquid assets (see <a href="https://www.ibm.com/docs/en/bfmdw/8.8?topic=accord-basel-iii-summary" rel="nofollow noreferrer">Basel III overview</a>). To be more specific banks have to maintain certain levels of Liquidity Coverage Ratio (LCR) and reserves are highly liquid.</p>
<p>Hence even though <em>de jure</em> capital requirements are abolished, <em>de facto</em> banks still need those reserves to function under Basel III. However, now there is no simple rate of required reserves for every single loan banks make, rather each bank needs different fraction of reserves depending on the riskiness and liquidity of the loans they issue.</p>

CC BY-SA 4.0
2022-08-08T17:03:05.383Z
@user253751, debt is never money. Credit cards are not money either.
Alex
CC BY-SA 4.0
2022-08-08T17:04:12.753Z
To compute LCR you need to figure out HQLA,which consists also of Level 1 assets, which in turn include Federal Reserve bank balances, foreign resources that can be withdrawn quickly, securities issued or guaranteed by specific sovereign entities, and U.S. government-issued or guaranteed securities. Insofar, it does not change the LCR as much as I know.
Alex
CC BY-SA 4.0
2022-08-08T17:49:53.823Z
Bonds are simply not part of US monetary aggregates. You usually cannot pay anything with a bond. You can sell the bond to receive money which you can in turn use to pay for things. The repo market is gigantic and wouldn't exist if you could outright use bonds like cash (money).
Alex
CC BY-SA 4.0
2022-08-08T18:22:15.347Z
@1muflon1 thanks for your answer (+1).  youve helped me a lot on this site.  i will have some questions shortly
Mr. Cooperman
CC BY-SA 4.0
2022-08-08T18:26:31.093Z
@Alex re: "debt is never money."  It seems to me that commercial bank credit is debt (what is credit generally besides a debt?) which is certainly money, in fact the vast majority of the money supply. do you disagree?
Mr. Cooperman
CC BY-SA 4.0
2022-08-08T19:44:02.610Z
@Alex Bonds do not matter for LRC, but they matter for capital requirement, **in my answer I am saying CB reserves matter for LRC not bonds**
1muflon1
CC BY-SA 4.0
2022-08-08T20:01:57.777Z
Bank credit is not money either. Granting a credit will create a deposit which is money. Credit is not money.
Alex
CC BY-SA 4.0
2022-08-08T20:05:21.603Z
@1muflon1, but government bonds do matter for LCR because these are part of the same level 1 hqla as reserves.
Alex
CC BY-SA 4.0
2022-08-08T20:59:16.923Z
your first paragragh actually gets to something I asked in a separate question https://economics.stackexchange.com/questions/45849/do-fed-omos-directly-and-immediately-increase-m1-or-m2-if-they-buy-treasuries-fr  .  My confusion there, which I still have, is that the "new money to conduct OMOs" is in the form of central bank reserves which are not counted in the M_i aggregates, as far as I know.
Mr. Cooperman
CC BY-SA 4.0
2022-08-08T21:36:40.157Z
@Timkinsella reserves are counted in M_i https://www.federalreserve.gov/faqs/money_12845.htm
1muflon1
CC BY-SA 4.0
2022-08-08T21:40:13.057Z
@1muflon1 that link says they're part of the monetary base but not M1 M2 etc
Mr. Cooperman
CC BY-SA 4.0
2022-08-08T21:44:31.233Z
this diagram i find helpful https://images.app.goo.gl/UCMkxJyqEpKcPEAcA
Mr. Cooperman
CC BY-SA 4.0
2022-08-08T22:42:47.787Z
Reserve balances ([currently 3,228.4](https://www.federalreserve.gov/releases/h6/current/default.htm)) are part of the monetary base, which is the sum of currency and said reserve balances, but they are not part of M1, which consists of [currency (the other part of the MB), demand deposits and other liquid deposits](https://fred.stlouisfed.org/release/tables?rid=21&eid=1217622#snid=1217624).
Alex
CC BY-SA 4.0
2022-08-08T22:52:24.380Z
@Timkinsella monetary base is M_0 so it is part of M_i for i=0.
1muflon1
CC BY-SA 4.0
2022-08-08T23:05:33.837Z
ah i see, agreed.
Mr. Cooperman
CC BY-SA 4.0
2022-08-08T09:57:57.147Z
2022-08-08T10:09:49.067Z
2022-08-08T10:09:49.067Z
1muflon1
<p>Is there anything facially stupid about the following argument that fed open market operations don't affect the money supply?  And if not, are there any professional economists who have made this argument?</p>
<p>When the fed buys or sells treasury bonds they are not changing the broader stock of highly liquid assets that include treasury bonds (is that m3?), since they are just exchanging one of the components (cash) for another (govt bonds).  Since there are no reserve requirements for commercial banks -- only <em>capital</em> requirements -- this doesn't actually affect the rate of credit creation since a bank that exchanges a dollar of central bank reserves for a dollar of us treasury debt is just as well capitalized as it was before.</p>

CC BY-SA 4.0
2022-08-08T17:24:18.273Z
https://www.google.com/url?sa=t&source=web&rct=j&url=https://www.ecb.europa.eu/pub/pdf/scpwps/ecb.wp2463~a4ccd343fb.en.pdf&ved=2ahUKEwjA0JqH4bf5AhWZVPEDHTQ6BKMQFnoECA0QAQ&usg=AOvVaw2av73BXfWIJqYZllIdrs5m explains the connection between banks reserves and broad money.
Alex
CC BY-SA 4.0
2022-08-08T17:56:48.333Z
Do you have a source for your question? In fact,  "When the fed buys or sells treasury bonds they are not changing the broader stock of highly liquid assets." is certainly correct (and most likely refers to LCR I suppose).
Alex
CC BY-SA 4.0
2022-08-08T18:29:06.970Z
@Alex no it was just something that occurred to me, cobbled together from my limited understanding of central and commercial banking
Mr. Cooperman
<federal-reserve>
What's wrong with this argument that the fed's OMOs don't change the money supply
Mr. Cooperman
# What's wrong with this argument that the fed's OMOs don't change the money supply

(Asked by: username_0 on 2022-08-08)

Is there anything facially stupid about the following argument that fed open market operations don't affect the money supply? And if not, are there any professional economists who have made this argument?

When the fed buys or sells treasury bonds they are not changing the broader stock of highly liquid assets that include treasury bonds (is that m3?), since they are just exchanging one of the components (cash) for another (govt bonds). Since there are no reserve requirements for commercial banks -- only *capital* requirements -- this doesn't actually affect the rate of credit creation since a bank that exchanges a dollar of central bank reserves for a dollar of us treasury debt is just as well capitalized as it was before.

**Tags:** federal-reserve
> **Comments:**
> **username_1**: https://www.google.com/url?sa=t&source=web&rct=j&url=https://www.ecb.europa.eu/pub/pdf/scpwps/ecb.wp2463~a4ccd343fb.en.pdf&ved=2ahUKEwjA0JqH4bf5AhWZVPEDHTQ6BKMQFnoECA0QAQ&usg=AOvVaw2av73BXfWIJqYZllIdrs5m explains the connection between banks reserves and broad money.  
> **username_1**: Do you have a source for your question? In fact,  "When the fed buys or sells treasury bonds they are not changing the broader stock of highly liquid assets." is certainly correct (and most likely refers to LCR I suppose).  
> **username_0**: @Alex no it was just something that occurred to me, cobbled together from my limited understanding of central and commercial banking  

---

## 2 answers

### Answer by username_2 on 2022-08-08. Score: 2 | Accepted answer

M3 isn't even published anymore in the US (it did not include bonds though).

As Alex noted, the LCR is entirely unaffected if the FED purchases government bonds because both are level 1. See for example this [BIS paper](https://www.google.com/url?sa=t&source=web&rct=j&url=https://www.bis.org/publ/qtrpdf/r_qt1212g.pdf&ved=2ahUKEwjXiYCB7Lf5AhXAYPEDHX1lAkgQFnoECA8QAQ&usg=AOvVaw2c0uqFq3624W07Ups0mj1A) on P.58 for a simple example demonstrating this.

Moreover,
the Fed cannot control the federal funds

> rate through routine changes in the quantity of reserves, also known
> as open market operations (OMO)

as copy pasted from [this FED note about the ample reserves regime](https://www.federalreserve.gov/econres/notes/feds-notes/implementing-monetary-policy-in-an-ample-reserves-regime-the-basics-note-1-of-3-20200701.htm). This is a direct effect of the ample reserves regime, where the [reserve requirement ratio is zero](https://www.federalreserve.gov/monetarypolicy/reservereq.htm#:%7E:text=As%20announced%20on%20March%2015,requirements%20for%20all%20depository%20institutions).

Generally, OMO can mean a lot of things (purchase of all sorts of securities) but (ignoring the title), I think the main argument is about the purchase of government bonds? For short, this does neither affect the interest rate (in an ample reserves regime), nor the liquidity ratio (LCR) / capital requirement of a bank. The latter statement requires that the central bank is purchasing a highly liquid (level 1) asset though (which US government bonds are).

Insofar, as written in your post, a purchase of government bonds by the FED has

> no direct impact on credit creation,

at least not via the LCR or interest rate channel. I am inclined to believe that this was the argument made by whoever you heard this from. I am less convinced they mentioned money supply because traditionally the monetary base is defined as currency in circulation plus reserve balances and while there are more liquid types, none include bonds in the US in any case (there used to be M4 and L which included T-bills but these were stopped long ago).

Lastly, the implementation of monetary policy has evolved considerably and repeatedly since the financial crisis. The FED also does not (anymore) target monetary aggregates when conducting monetary policy. I believe reading [this answer](https://economics.stackexchange.com/a/49858/40033) might be interesting, although many others have different opinions about this subject.

**Edit**

Commercial bank credit is NOT part of M1. When a bank provides a loan, the borrower receives a deposit. From the perspective of commercial banks balance sheets, this increases credits on the assets side and customer deposits on the liabilities side. Most of the times (with mortgages it is frequently directly sent to seller of the house / or mortgage notary's account) this deposit is withdrawn quickly and usually sent to another bank (unless the seller's bank account is at the same bank as the buyer's). Therefore, an individual commercial bank cannot generate lasting increases in its deposits by granting loans.

However, the banking system as a whole does see an increase in deposits (thus money supply) despite constant amounts of central bank money. Leaving potential reserve requirements aside, the bank will still have risk/return considerations to take into account when providing loans. From an asset liability management perspective, loans are long-term claims on the assets side, while sight deposits are typically liquid and short-term liabilities. In essence, that is one of the main reasons justifying commercial banking - it's an intermediary that brings together investors and savers despite their diverging requirements. Banks can offer this service because they can diversify the credit and liquidity risks better than individuals.

For risk management, banks need to consider factors such as current and future
interest rate on loans and deposits, the likelihood of deposit withdrawals and credit defaults and the like. On top of this, banks are tightly regulated. Banks need to follow the standards of Basel III, which consist of 3 Pillars

* Pillar 1: Capital requirements ([Capital Ratio](https://en.wikipedia.org/wiki/Capital_adequacy_ratio), [Leverage Ratio](https://en.wikipedia.org/wiki/Basel_III#Leverage_ratio),..), Credit risk, Market risk, [Operational Risk](https://en.wikipedia.org/wiki/Operational_risk) as well as [LCR & NSFR](https://www.ecb.europa.eu/pub/financial-stability/macroprudential-bulletin/html/ecb.mpbu201910_2%7E3237802727.en.html).
* Pillar 2: mainly supervision like the Supervisory Review Evaluation Process ([SREP](https://www.bankingsupervision.europa.eu/banking/srep/html/index.en.html#:%7E:text=This%20activity%20is%20called%20the,supervisory%20measures%20to%20be%20taken.), [ICAAP & ILAAP](https://www.eba.europa.eu/guidelines-on-icaap-and-ilaap-information),...
* Pillar 3: ...

Long story short, banks cannot simply give away loans without end. Also, credit creation by banks relies on a lot more details than the traditional reserve requirement (money multiplier) argument suggests. Specifically, it is not just the consideration of outflows (of deposits) and inflows being spread over time and normally only being a fraction of total deposits (which is where the name *fractional reserve banking* originated, as only a fraction of customer deposits have to be covered all the time). Since deposits created by the banking
system belong to the banks’ customers, the main driving force behind credit creation are customers, not banks themselves.

In fact, the FED does not even aim to affect the broad money supply. St.Louis FED research claims it's best to forget what we learnt about money aggregates in [undergrad Econ](https://research.stlouisfed.org/publications/page1-econ/2021/09/17/teaching-the-linkage-between-banks-and-the-fed-r-i-p-money-multiplier). The so called *dual-mandate* aims to (somewhat interestingly) promote three (not two) goals: maximum employment, stable prices, and moderate long-term interest rates

Neither of these goals mentions money supply. Also, [New York FED -
Money Supply](https://www.newyorkfed.org/aboutthefed/fedpoint/fed49.html) states that

> In 2000, when the Humphrey-Hawkins legislation requiring the Fed to
> set target ranges for money supply growth expired, the Fed announced
> that it was no longer setting such targets, because money supply
> growth does not provide a useful benchmark for the conduct of monetary policy.

and [FED - what is money supply](https://www.federalreserve.gov/faqs/money_12845.htm) claims that

> Over recent decades, however, the relationships between various
> measures of the money supply and variables such as GDP growth and
> inflation in the United States have been quite unstable. As a result,
> the importance of the money supply as a guide for the conduct of
> monetary policy in the United States has diminished over time

[This answer](https://economics.stackexchange.com/a/49858/40033) has a few charts illustrating that total money supply is not really directly impacted by monetary policy. For example, normalizing each series to Dec 2005 = 100 (monetary base - [BOGMBASE](https://fred.stlouisfed.org/series/BOGMBASE), [M1](https://fred.stlouisfed.org/series/WM1NS) - be careful, the definition changed in May 2020 if you look at the data on FRED, [M2](https://fred.stlouisfed.org/series/WM2NS)), the data looks like this (the code to replicate this is in the link: QE stands for quantitative easing)

[![enter image description here](https://i.sstatic.net/muKZf.png)](https://i.sstatic.net/muKZf.png)

The dual-mandate got its name from employment and the price level, because under [full employment](https://en.wikipedia.org/wiki/Full_employment) (not no unemployment), and stable prices, interest rates settle at moderate levels. For details, you can read [Frederic S. Mishkin (2007) speech at Bridgewater College](https://www.federalreserve.gov/newsevents/speech/mishkin20070410a.htm).

To summarize, the main goals of the FED are to keep prices stable and to promote full employment (closely related to a healthy economy / GDP). However, as just seen, there is only a weak relationship between measures of the money supply and GDP growth and inflation. Therefore, the central bank focuses on interest rates, not only the FED Funds market, but also longer term interest rates. Changing interest rates has a direct impact on demand for credit (by customers) and the risk metrics of banks (current and future interest rate on loans and deposits, the likelihood of deposit withdrawals and credit defaults, Basel III calculations, ...).

As written above, monetary policy has evolved considerably. For example, in the EUR area, so called Targeted longer-term refinancing operations (TLTROs) aim to offer commercial banks attractive long-term funding conditions. To stimulate lending to the real economy, the interest rate is negative and in a nutshell, the more loans participating banks issue to non-financial corporations and households (except loans to households for house purchases), the more attractive (the more negative) the interest rate. While ultimately there needs to be demand from customers, these favourable funding conditions make it easier (cheaper) to offer loans.

> **Comments:**
> **username_0**: Thanks lots of great resources here -- the stuff on the ample reserve regime is particularly enlightening and puts a name to something i wondered about for a while (namely, how can changes in total bank reserves really matter when banks are already sitting on massive excess reserves?).  I'm a little confused where you come down though.  It seems like you agree that there's "no direct impact on credit creation" but not that there's no effect on the money supply.  When I said "money supply" in my post i wasn't referring to the monetary  base (continued...)  
> **username_0**: The monetary base obviously increases with the creation of new reserves when the fed buys assets like govt bonds from commercial banks.  By "money supply" i meant a measure like M1, i.e. something like cash and coins plus commercial bank credit.  So if the fed's bond purchases don't expand commercial bank credit I don't see how they can affect the money supply.  
> **username_0**: Thanks so much again for the added info.  The only remark I have is when you say "Commercial bank credit is NOT part of M1" I think you and I must be using the word "credit" in different ways.  All I mean by "credit" is electronic deposits at commercial banks -- ie what's in my checking account right now.  Surely that is part of M1, right?  Probably I am just misusing the word "credit".  Although i'm not sure what "commercial bank credit" *would* refer to if not these deposits.  
> **username_2**: [Commercial bank credit](https://fred.stlouisfed.org/series/TOTBKCR) is an asset of banks, whereas deposits are liabilities. Bank credit is the first entry on the asset side, and deposits are the first entry on the liability side of the [Assets and Liabilities of Commercial Banks in the United States - H.8](https://www.federalreserve.gov/releases/h8/20220729/).  Frequently credit and loans are used interchangeable to refer to financing, but strictly speaking these are [distinct types of financing](https://www.bancosantander.es/en/faqs/particulares/prestamos/diferencias-prestamo-credito).  
> **username_2**: A checking account derives its name from the standard method of making a withdrawal, which was by writing a cheque. While this method is a bit archaic, the name checking account still exists and is essentially the same as a current account or deposit account (a type of account that accepts deposits, where you can withdraw in a number of ways - cheque, debit card, ATM machine etc.). Either way, they are liabilities for banks (as long as there is a positive sum on the account).  
> **username_0**: ah so "bank credit = bank deposits" isn't even an accounting identity?  so i really need to start saying "deposits" instead of "credit".  
> **username_0**: i think what created the confusion is i hear so much talk about "credit creation" which i take to mean the creation of new deposits when banks make loans. but it sounds like youre saying "credit" in that phrase is really referring to the loan, not the deposit.  

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### Answer by username_3 on 2022-08-08. Score: 1

OMOs do increase money supply. When central bank conducts OMOs it does not use pre-existing money in the economy, it creates new money to conduct OMOs. OMOs would also increase money supply even without existence of private bank.

> When the fed buys or sells treasury bonds they are not changing the broader stock of highly liquid assets that include treasury bonds (is that m3?)

US bonds are generally not M3 because average maturity of US bonds is 65 months (see [Peterson Foundation](https://www.pgpf.org/blog/2021/01/how-does-the-treasury-issue-debt#:%7E:text=More%20recently%2C%20average%20maturity%20has,24%20percent%2C%20while%20the%20share)) and M3 includes only debt securities with maturity less than 2 years (see [OECD](https://data.oecd.org/money/broad-money-m3.htm#:%7E:text=Broad%20money%20(M3)%20includes%20currency,securities%20up%20to%20two%20years.)). In any case even if you would count all bonds in your preferred measure of money supply the bond would still exist and new cash that previously not existed was created so the measure of money supply would still increase. When central bank buys bonds it does not automatically destroy them the way it automatically destroys cash when it sells bonds.

> Since there are no reserve requirements for commercial banks -- only capital requirements -- this doesn't actually affect the rate of credit creation since a bank that exchanges a dollar of central bank reserves for a dollar of us treasury debt is just as well capitalized as it was before.

No this is actually not true. The new capital requirements depend on type of debt banks are holding. Banks generally need less capital for government bonds then private loans under Basel III.

Moreover, the term 'capital requirements' is somewhat misleading. Capital requirements under Basel III also specify that banks have to have some level of liquid assets (see [Basel III overview](https://www.ibm.com/docs/en/bfmdw/8.8?topic=accord-basel-iii-summary)). To be more specific banks have to maintain certain levels of Liquidity Coverage Ratio (LCR) and reserves are highly liquid.

Hence even though *de jure* capital requirements are abolished, *de facto* banks still need those reserves to function under Basel III. However, now there is no simple rate of required reserves for every single loan banks make, rather each bank needs different fraction of reserves depending on the riskiness and liquidity of the loans they issue.

> **Comments:**
> **username_1**: @user253751, debt is never money. Credit cards are not money either.  
> **username_1**: To compute LCR you need to figure out HQLA,which consists also of Level 1 assets, which in turn include Federal Reserve bank balances, foreign resources that can be withdrawn quickly, securities issued or guaranteed by specific sovereign entities, and U.S. government-issued or guaranteed securities. Insofar, it does not change the LCR as much as I know.  
> **username_1**: Bonds are simply not part of US monetary aggregates. You usually cannot pay anything with a bond. You can sell the bond to receive money which you can in turn use to pay for things. The repo market is gigantic and wouldn't exist if you could outright use bonds like cash (money).  
> **username_0**: @1muflon1 thanks for your answer (+1).  youve helped me a lot on this site.  i will have some questions shortly  
> **username_0**: @Alex re: "debt is never money."  It seems to me that commercial bank credit is debt (what is credit generally besides a debt?) which is certainly money, in fact the vast majority of the money supply. do you disagree?  
> **username_3**: @Alex Bonds do not matter for LRC, but they matter for capital requirement, **in my answer I am saying CB reserves matter for LRC not bonds**  
> **username_1**: Bank credit is not money either. Granting a credit will create a deposit which is money. Credit is not money.  
> **username_1**: @1muflon1, but government bonds do matter for LCR because these are part of the same level 1 hqla as reserves.  
> **username_0**: your first paragragh actually gets to something I asked in a separate question https://economics.stackexchange.com/questions/45849/do-fed-omos-directly-and-immediately-increase-m1-or-m2-if-they-buy-treasuries-fr  .  My confusion there, which I still have, is that the "new money to conduct OMOs" is in the form of central bank reserves which are not counted in the M_i aggregates, as far as I know.  
> **username_3**: @Timkinsella reserves are counted in M_i https://www.federalreserve.gov/faqs/money_12845.htm  
> **username_0**: @1muflon1 that link says they're part of the monetary base but not M1 M2 etc  
> **username_0**: this diagram i find helpful https://images.app.goo.gl/UCMkxJyqEpKcPEAcA  
> **username_1**: Reserve balances ([currently 3,228.4](https://www.federalreserve.gov/releases/h6/current/default.htm)) are part of the monetary base, which is the sum of currency and said reserve balances, but they are not part of M1, which consists of [currency (the other part of the MB), demand deposits and other liquid deposits](https://fred.stlouisfed.org/release/tables?rid=21&eid=1217622#snid=1217624).  
> **username_3**: @Timkinsella monetary base is M_0 so it is part of M_i for i=0.  
> **username_0**: ah i see, agreed.  

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