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Wednesday, August 16, 2017

Primer: Money Neutrality

Note: This article is an excerpt from "Abolish Money (From Economics)! "(chapter 5). The book is available at online bookstores.

Big errors start from smaller ones. In economics, the plausible concepts of money neutrality and the velocity of money have led to many problems. This essay defines these concepts; I discuss the difficulties with them in later sections.

Money Neutrality

The idea of money neutrality is simple: monetary values are a unit of measurement for market transactions, and that if we change the units of measurement, it does not affect the real value of transactions.

There is a simple real-world experiment that appears to validate this idea: currency redenomination. For example, General Charles de Gaulle of France created the nouveau franc on January 1, 1960, by striking the last two digits off calculations of existing French francs in circulation.*  In other words, a nouveau franc is just 100 old francs, and contracts were adjusted to compensate. The objective was to return nominal prices back to what feel like “normal” levels after inflation.

It is clear that just multiplying all monetary values by some constant is not going to make people better off – other than the convenience value of returning prices to levels that people consider to be “normal.” Within an economic model, the implication is that if we scale monetary values by some constant, the model dynamics for real variables should not be changed. That is, the model output is neutral with respect to the monetary unit.

Formally defining money neutrality is difficult (outside of a currency redenomination). This is discussed further in “The Incoherence of Money Neutrality” (Section 11). For the present, I will stick with a hand-waving definition: changing the stock of money (in a real-world economy, or in an economic model) will not affect real variables. (Although this is close to the definitions normally used, the previously referenced essay explains why this definition is problematic.)

The concept is quite often broken down into long-run and short-run neutrality. Models such as Real Business Cycle models  have the property that changes in money have no effect on real variables at any time, which is the definition of short-run neutrality (money is neutral, even in the short run). However, it is unclear whether Real Business Cycles are anything other than an elaborate practical joke.

Long-run money neutrality is more commonly encountered. The argument is that operations that change the money stock may have a short-term effect on real economic variables, but in the long term, the only effect on changes in monetary aggregates is via changes in the price level.

Velocity of Money

Money velocity is a concept that has caused considerable grief. Although we can always calculate the “velocity of money,” it is unclear whether it is useful in practice. If velocity were constant, the classical Quantity Theory of Money would result.

Within the history of monetary economics, the equation
M∙V = P∙Q
is of utmost importance. Within the equation, M stands for the money supply, V for the velocity of money, P for the price level, and Q for the quantity of output. The quantity P∙Q is the dollar value of output (price times quantity), or nominal GDP. The intuition is that the velocity is the number of times the money supply circulates in a year.

If velocity were constant, we could use this equation to develop strong conclusions about the relationship between the money supply and nominal GDP (and the price level). Doubling the money supply would double nominal GDP.

Furthermore, if we accept that money neutrality is at least roughly correct, we would expect real output (Q) to be largely unaffected by the doubling of the money supply. In which case, the implication of a constant velocity is that the price level (P) would (at least roughly) double. This matches the simpler definitions of the Quantity Theory of Money.

Of course, if we note the difficulties associated with exogenous money previously noted, the value of this insight is limited – how exactly is the money supply going to double?

In any event, empirical analysis shows us that velocity is nowhere near constant. This empirical analysis is pursued at greater length in “Instability of Money Velocity.” [Which appears as another section of the book. This online article looks at some money data, and the instability of the velocity of money.]

Concluding Remarks

Money neutrality and the velocity of money appear to be reasonable concepts. The difficulty is attempting to apply them to the real world.

Page with links to online booksellers.


* Milton Friedman, on page 21 of Money Mischief: Episodes in Monetary History. Published by Harcourt Brace Jovanovich, 1992.

(c) Brian Romanchuk 2017


  1. "Abolish Money From Economics"?

    Sounds to me like "abolish living things from biology", or "abolish Building Construction Materials from civil engineering", or "abolish god from religion".

    I mean, money is an integral part of economics, isn't it?

    The fact that economists don't know how money works doesn't make it a taboo...

    I guess we should ask for "Abolish Bad Theories from Economics"...

    As a person in the MMT paradigm, I believe that money plays a fundamental role in the public/private resources allocation. So it is essential that economists know how it works and make better policies based on that knowledge...

    1. The point is that it is too integral. In the grand scheme of things, money is not that important for the economy.

      Getting "money" out of MMT would cause a little bit of re-writing of existing texts, but it's not that critical. We can just re-phrase to say that the government can always lock its short-term borrowing rate at 0%.

    2. "In the grand scheme of things, money is not that important for the economy."

      Well, than we profoundly disagree. I believe that money is fundamental to the economy. Unfortunately, I will not be able to elaborate on that topic now, but I hope some day we will be able to discuss it...

      “We can just re-phrase to say that the government can always lock its short-term borrowing rate at 0%.”

      I couldn’t understand. Locking the short-term borrowing rate at 0% and abolishing money are equivalent things? I got a little lost here...

      What about all the resource allocation aspects of fiscal policy? What about JG program described by MMT community (Bill Mitchell)? Some MMTers, like Warren Mosler, would say that unemployment was created when money was created. With no money, no unemployment would exist.

      I feel that our understanding of the economic world is so different that I cannot even know exactly how to start discussing the theme...

    3. Note that my argument is about economic theory, not money in the economy. The fact that modern economies use monetary exchange is important. At the same time, the fact that we breath oxygen is also important. However, there is no room within economic models to incorporate oxygen-breathing.

      What does the resource allocation aspects of fiscal policy have to do with money? Money is just a short-term debt instrument; how can it affect the results of fiscal policy? The MMT arguments about "money financing" are equivalent to "0% interest financing". You get the same outcome - "financial constraints" allegedly created by bond markets disappear.

      In practical terms, when was the amount of money outsanding an important variable for predicting what would happen in the economy? (I will put aside the whole sorry QE episode, as it is hopelessly controversial.)

    4. Brian is right. Money is utterly irrelevant to the MMT position - which is that real things matter and that the government has total control over the resources within its borders if it wants to exercise that power.

      Once the government decides to do something, the wonks in the finance system can crank the handle and out pops the result.

      It's the petrol vs oil argument as to what is actually important in getting an engine to do something. An engine with petrol in it will still try to do something regardless of the level of oil. But if you have oil in the engine and no petrol nothing happens.

      Money is just oil.

  2. "The fact that economists don't know how money works doesn't make it a taboo..."

    That's a keeper...

  3. Brian, I am pretty sure Keynes was right when he said we live in monetary economies. People go to work and produce things in large part because they are going to be paid 'money', not some barter basket of goods. Firms invest and produce based on what amount of money they expect in return. And some people continue to desire 'money' and work to acquire it far beyond what they could possibly ever consume in terms of goods and services in their lifetime. Now things like monetary aggregates, (base money, M2, M3, whatever) maybe you can make a good argument that these are more or less useless.

    Your book "Abolish Money (from Economics)" was very good, but it has a very unfortunate and unlikely title.

    Andre, I recommend you read the book- I am pretty sure you won't have any problems with it besides the name.

  4. Government Money (Monetary Base) are "receipts" received from supplying the government with labour, goods, services (and capital when e talk about the interest earned on loans to the government).

    Government authorities will enforce taxing. They will fiscalize and punish those who don't pay taxes according to law. Tax payment is nothing more than handing out to the government the "receipts" you earned to "prove" that you supplied the government, as every citizen should.

    So state, money, government spending and taxing are all related subjects, and fundamental to understanding economics and the society we live in. Base money is not gold or some commodity and cannot be treated as if it didn't exist - that wouldn't make sense.

    Bank deposits are nothing more than a specific kind of IOU - one promising to pay Base Money to the holder, on demand. If you want to understand bank deposits, you have to understand Base Money.

    Of course, if you want to remove the government or banks from economic sciences field, I guess there would be no problem in removing money too. But then what economics would be good for?

  5. The point is that it is [not?] too integral. In the grand scheme of things, money is not that important for the economy.
    Giant disagree, if you mean anything like neoclassicals. As explained above, "money" is utterly integral to the monetary economics of monetary production economies.

    Getting "money" out of MMT would cause a little bit of re-writing of existing texts, but it's not that critical. We can just re-phrase to say that the government can always lock its short-term borrowing rate at 0%.

    This makes it clear that you aren't using the word "money" the way that many or most MMTers do, the way that MMT-stream thinkers worked hard to define. MMT, unlike mainstream econ tries to be close to common usage, not call a dog a canine-type hound. But one can get so used to unscientific academic usage that scientific, ordinary language can be confusing. :-) That is the problem of public miseducation in economics in a nutshell. As Keynes complained about Ricardo, doctrines which were both counter-intuitive and false won and were drilled into everyone's mind. Not talking about the core of one's theory and focusing on the peripherals is standard, but imho bad academic practice. Beyond using sensible language, the critique of "abolishing money" is precisely on economic theory. The critics's points are more "theoretical" than the abolitionists (unconscious) assumptions. Getting "money" as defined in MMT, out of MMT would eviscerate the subject.

    The fact that modern economies use monetary exchange is important.

    Modern economies don't use monetary exchange. That's because money is not a medium of exchange. "There is no medium of exchange." (Mitchell-Innes)

    1. I would suggest that oxygen is even more important. Without it, we all die. Why do we not stick oxygen in economic models?

      My point is about economic models, and how money appears as a variable in those models. You and André are discussing verbal concepts of money, which is not what I am referring to.

  6. I would suggest that oxygen is even more important

    No, oxygen is of no importance in monetary economics. One can conceive of monetary economics without oxygen. But not monetary economics without money.

    My point is about economic models, and how money appears as a variable in those models.

    Fine. If you restrict it to this, to some sufficiently well-defined but restrictive "money" in some particular model, then we might even agree in some respects. I've seen MMT economists say things that tend that way - but a great deal more carefully! But this is very far from "abolishing money", or suggesting that "Getting money out of MMT would cause a little bit of re-writing of existing texts, but it's not that critical."

    You and André are discussing verbal concepts of money, which is not what I am referring to.

    Andre & I are not the ones who are being sloppy. More restrictive concepts - you haven't made clear exactly what you mean by "money" - cannot be understood and used without the "verbal concepts" of which they are a specialization, and which are thus equally "verbal". So artificially, absolutely separating "variables that appear in models" and "verbal concepts" is quite wrong. "Variables" are just "pronouns".

    In the grand scheme of things, money is not that important for the economy. This is quite difficult to understand, it may be using several concepts of money at once, and seems to be one of the wrongest, anti-MMT, anti-common sense statements here.

    To Neil also: MMT is concerned with both the "real" & the "nominal/financial/monetary" and carefully distinguishing them and often talking about them at the same time. Not doing this is a very common source of error. Similar statements I've made at Naked Cap & NEP garnered agreement from Randall Wray & Scott Fulwiller.

    Evaluation of such - or most other ones I have seen - recommendations to "improve" MMT could be aided by looking at the history of the decline & fall of Keynesian economics. For they're usually the same "improvements" that turned the sensible economics of 1950 into neoclassical with improved confusion, complication and obscurity. Abolish money, etc?: Been there, done that, didn't work.

    1. Well, it seems the title has got you hooked Cal. You really should read the book and see if you disagree with more than the title. It is good and fairly inexpensive for the e-book. If you do read it, I doubt you will disagree with it more than I did here. Or here-

    2. Get a mathematical model, with a variable labelled "money". Is it really that important? Otherwise, name me one instance where the level or the rate of change (or whatever) of some monetary aggregate (e.g., M1) really mattered for an economic outcome.

      If you cannot do that, "money" - as it is normally defined in economics - does not matter.

    3. But Brian, isn't there a difference between money aggregates like M1 which no individual or company bases their behavior on much at all and actual money? You know, the stuff you pay your employees with and buy food and pay the rent and all that other stuff? Please, please don't tell me I have to go to work today because M2 is gonna suffer if my customer doesn't draw down the loan he got to fix his house and if I don't go then he can't pay me and M2 won't be increased and everything is all screwed up.

      Here in the very enlightened USA we have this thing called powerball. Its some kind of ridiculously impossible lottery scam that has the effect of making millions of people go to a convenience store and buy lottery tickets every other day it seems. Just for the ridiculously slim chance of winning I think 600 million dollars this week. Unfortunately, everyone seems to be doing this for the MONEY. It is quite a phenomena in human behavior, and I am not sure how it can be explained without referring again to the MONEY. Do you have any theories on this?

    4. Some economists refer to state run lotteries as the "stupid" tax. The smart guys like Warren Buffet study cash flow patterns and pricing power to accumulate wealth based on the customs of the "herd". Get cash flow positive on a series of investments that trade up in value - then buy the brains of actuarial scientists and investors operating insurance companies. If the actuaries price risk properly then one accumulates a fortune by paying out less then one accumulates via insurance premiums and gains on invested funds using those premiums as "other peoples' money" without passing on any interest rates to investors.

      When you look at the banking system as an aggregate the so-called M1 and M2 money supply are simply part of the "mix" of bank liabilities and equity. The identity assets equals liabilities plus equity always holds so M1/M2 are simply part of a mix of liabilities and equity that fluctuates based on complicated market interactions between banks and customers. There is no necessary correlation between any single item of bank liabilities and macroeconomic outcomes. However during a money market crisis equity will be destroyed at a rapid rate in the whole economy as we saw the stock market plunging in fall of 2008 due to a debt market crisis. Fiscal policy is the primary weapon against a debt-deflation and it is the proximate cause of rampant inflation if the credit system is also expanding balance sheets while the government runs too much deficit spending to people who bid up prices of goods and services. What role does "money" per se play in the process? It is a residual investment of those who prefer liquidity and fixed net asset value investments at a given time based on other factors.

    5. Get a mathematical model, with a variable labelled "money". Is it really that important? Otherwise, name me one instance where the level or the rate of change (or whatever) of some monetary aggregate (e.g., M1) really mattered for an economic outcome.

      The national debt is one monetary aggregate that MMT considers. Changes in it are of course the deficit. You really don't think their whatevers can matter? A first lesson of MMT or Keynesian policy is saying that numerological obsession with these whatevers - e. g. budget balancing - can matter drastically to "the real economy."

      I think we may agree about substance (the usual unimportance of M1 etc, abolishing the concept of money as a medium of exchange) but my assertion is that because you consider "money" far too restrictively (& unreflectively?), what you are saying is obscured. What is the "normal definition" you mean? M1 etc are pretty recent ideas - dating only from the early 60s. Are you identifying them as "money as it is normally defined in economics"? You seem to be. So this is historically inaccurate - and that it avoids the heart of the matter is my contention.

      For "re"defining, understanding money, understanding the uselessness and unintelligibility of the the "normal definitions" whatever they are - is the core of MMT. MMT is (the very model of?) a modern mathematical theory :-) - it's all in the definitions. So going on to "Abolishing money" is a horrible way of saying what I think you are saying. My usage (a more extreme version of MMT) is not exactly the same as ordinary speech, but tries to be as close as possible, and imho is conceptually much less sloppy and confusing than the restrictive terminology.

      On titles, Geoffrey Gardiner's title for the first edition of his book, that he (& Wray) considered basically the UK equivalent of Wray's Understanding Modern Money is "Towards True Monetarism", which is a good description of MMT & explanation of how to use the word "money".

  7. "Get a mathematical model, with a variable labelled "money". Is it really that important?"

    Well, let's consider a variable named government spending". I hope we both will agree that it's of utmost importance to the economy. But does government spend in gold? Does it spend in iron? Rice? Chikens? No, government spends in money (M0).

    If you want to discuss government spending, you have to discuss money. You can't simply pretend that government spending doesn't exist, or that it spends in non-money things...

    1. It's denominated in money, I get that. Is the money supply variable (which is what everyone else refers to when thinking about "money") meaningful as a result? No.

    2. It's not just "denominated in money", it IS money. Coca-cola price is denominated in money, but M0 is money itself.

      Well, when politicians are discussing the budget, money is meaningful. Should I spend in health care, military, education? How much to each agency? Should I spend more or less, in total? Should I raise or lower taxes? What taxes, by how much? Should I create a law that specifies a spending limit? Debt limit? Would that be good to the public purpose that my constituents want?

      You cannot discuss this sort of very important economic themes by pretending that money is a commodity like cattle or salt. I mean, you cannot say “as an economist, the debt level should be 3 billion oxen”. You also will be unable to discuss these sorts of things if you want to abolish money...

    3. The two components of M0 are bank reserves and currency in circulation. If I read/understand correctly Brian stated that M0 is equivalent to a zero interest government bond. This is functionally true if you consider the central bank to be part of the government due to its public purpose(s).

      In the US when Treasury deficit spends it sweeps issues mostly electronic securities (bills, notes, bonds, etc.) to banks and nonbanks at auction, this sweeps funds into Treasury accounts in banks and at the central bank, and Treasury spends funds back at roughly the rate of borrowing sending approximately the same of amount of funds back into the banking system. The net result is that banks and nonbanks hold more Treasury securities with almost no change in reserves or deposits on the aggregate bank balance sheets. So the float of Treasuries increases at the rate of deficit spending and the aggregate bank operations are not disturbed by Treasury cash and debt management.

      The central bank decides the level of reserves in M0 and the nonbank sector decides how much currency to withdraw and hold from the bank sector. In some states of the world, when there are not large excess reserves, the central bank will buy or sell Treasuries to offset changes in the currency float. Therefore the public has a choice: hold currency or hold Treasuries in the float of assets issued by the government.

      The M0 money can be viewed as zero interest debt of the government without any necessary correlation to macro-economics. The deficit spending and credit expansion of the bank and nonbank financial sectors, however, influence aggregate demand, and the central bank does have some control over price stability although it may need fiscal help from the government under some states of the world.

    4. André - think of it as "abolishing monetary aggregates" from economics. That results in a much less interesting title. As can be seen, "abolishing money" from economics generates more controversy. The unit of account is a seperate issue from the time series that are monetary aggregates.

    5. Just looked here below my first comment and see we largely agree. Here are some repetitious quibbles.

      The money supply variable (which is what everyone else refers to when thinking about "money"

      Only if "everyone else" means "most post 1960s economists."
      And as I note above, not all monetary aggregate (changes) are meaningless.

  8. Joe Leote, state run lotteries are definitely a 'stupid' tax. The average return on a bet is less than 50% I think. And then you have to pay tax on the winnings if they are large enough. And although it can be described as a voluntary tax, these gambling games turn out to be highly regressive taxes where the poor who see no other hope for income pay to play more frequently. In my opinion- ain't got no stats for that. Plus it takes advantage of people who have a gambling problem, which isn't what I want my government to be doing.

    Despite that, I will probably buy a ticket for the powerball thing, if I remember. Because I am not all that logical and enjoy thinking about what I would do with all that MONEY if it turned out that my one in three hundred million chance actually came through.

    As to the second paragraph of your comment- I am afraid I don't understand it at all. Which by no means indicates it is wrong in any way.

  9. Jerry Brown,

    What happens in Vegas stays in Vegas. What happens in the aggregate bank balance sheet stays in the aggregate bank balance sheet.

    To understand M1/M2 as components in a flexible mix just make a simple model of the aggregate bank balance sheet as follows:

    Loans + Securities + Reserves = Checking + Saving/Time + Borrowing + Equity

    Banks make a profit on fees and on the interest rate spread between performing assets (loans, etc) and cost of liabilities and equity, so the asset side of the balance sheet tends to expand. To support the asset side banks must develop a mix of liabilities and equity by dealing in money and credit markets. This mix is flexible. The component of M1 is checking deposits. The component of M2 is small saving and time deposits. There is no more definition of M3. There is no formal definition of bank borrowing via Eurodollars and repurchase agreements in money markets. If retail depositors make investments in money market funds the deposit transfer to the industrial money dealers and then banks are forced to do more repo or Eurodollar borrowings to keep from selling down assets and cancelling liabilities. The growth of assets is determined by the availability of creditworthy borrowers on the asset side and the mix of bank liabilities is flexible when money and credit markets are properly functioning. Thus levels of M1/M2 are not correlated with any macro-economic variable as Brain argues.

    Perhaps that did not clarify - the jargon can be difficult to describe in a relatively short comment.

  10. Hopefully I am understanding you as saying the different monetary aggregates are not important. If that is the case, I agree. If that isn't what you are saying, I am lost.

    But if I have your attention, I would like your opinion on a slightly different aspect of money- namely excess reserves that the Fed pays interest on here in the US. I seem to have taken objection to Scott Sumner's latest post about that situation and need to know if I have been spouting a bunch of BS or if I'm on somewhat solid ground. For whatever reason, I have said that the commercial banking system, as a whole, would have a difficult time getting rid of it's excess reserves on it's own, without the Fed or the Treasury selling them assets for those reserves. Is this a reasonable statement? Or am I going to have to apologize to Sumner, which I really hate doing...

    1. Jerry Brown, although your question has nothing to do with this post, I will give you my view.

      "I have said that the commercial banking system, as a whole, would have a difficult time getting rid of it's excess reserves on it's own, without the Fed or the Treasury selling them assets for those reserves."

      Well, first of all, you have to understand in modern economies that central banks decide a level for the interest rate targets, and execute operations in the market to achieve that target. Usually central banks do that with remuneration on reserves or through open market operations. They are equivalent. But the point is that, today, central banks do not try to control directly the reserves.

      In modern economies, commercial banks will always try to maximize their profits. This means that they will choose a size for they balance sheet, and their asset/liabilities structure. If the Fed is paying big interest rates on reserves (or in open market operations), banks will probably change they balance sheet to accommodate more excess reserves (or open market operations) than otherwise. If the Fed is paying low (or negative) interest rates, then banks will avoid excess reserves. There is nothing like "difficult time getting rid of its excess reserves" - maybe banks will actually want a lot of excess reserves.

      It's the government role to define an interest rate target to achieve the public purpose, whatever it may be...

    2. Thanks Andre. But where do those reserves go to? Where can a bank send excess reserves to other than another bank or the Fed or the government? As far as being unrelated to the post, you are mostly right- but reserves are a type of money and we were talking bout money sort of... Don't get me in trouble with Brian too- I don't mind apologizing to him but can't stand the thought of telling Sumner he was right again. :)

    3. Jerry Brown,

      Loans + Securities + Reserves = Deposits + Borrowings + Equity

      Reserve levels are a liability of the central bank and financial assets of the aggregate bank sector. Since the central bank controls its own balance sheet the aggregate bank cannot increase or decrease the level of reserves. In a system with required reserves the central bank must provide the minimum requirement.

      Prior to the late 2008 financial crisis the Fed (central bank in US) provided only enough excess reserves to force a few banks to borrow at the Fed discount window as a means to control interest rates in the fed funds market. The Fed did not have to change reserve levels by much, if at all, to move the fed funds rate to whatever target, so it had roughly control over levels and interest rates.

      During the 2008 financial crisis the disruption in the money markets meant the aggregate bank could not rollover all of its uninsured deposits and borrowings - so these accounts would revert to checking deposits - there would be a large spike in checking deposits which are reservable - so there would be a spike in demand for required reserves. Fed originally let banks borrow those reserves and sold Treasuries from its balance sheet to keep control over the fed funds rate - but this was causing a problem - Fed might run out of Treasuries to sell even as banks (in aggregate) needed more reserves because they could not attract investors in large uninsured deposits, borrowings, and equity. Fed got authority to do quantitative easing (QE) also called large scale asset purchases (LSAP). This would not solve the problems of the aggregate bank if Fed only purchased securities from banks because banks hold securities and reserves in the liquidity cushion so a swap in that cushion does banks no good. QE works because Fed purchases securities from nonbanks, this injects reserves into the aggregate bank, and when banks clear payment, it injects new deposits into liability side of the aggregate bank. When QE increases checking deposits and reserves in equal measure it creates many excess reserves for two reasons. First, reserves are only required to be a fraction of reservable deposits, and second deposits can migrate from reservable categories to categories that do not impact required reserves.

      Can banks get rid of reserve levels? No because the central bank controls those levels in the aggregate bank. Can banks expand loans and deposits on a fixed level of reserves? Yes especially if there are many excess reserves - but banks need to find creditworthy borrowers which were not available due to the system already being saturated with too much debt.

      As far as how the bank sector would dispose of excess reserves I think the analysis is complicated because if loans expand so do reservable deposits (at first) but only a fraction of the reserves become "required" by that process in proportion to the amount of checking deposits created. The other complication is that when banks are short on excess reserves they induce the depositors to hold non-reservable liabilities by offering an interest rate premium. This means banks can reduce the level of excess reserves when creditworthy borrowers are systemically available and when money and credit markets support banks in developing what Hyman Minsky calls reserve-economizing liabilities. But if Fed wants to keep the system saturated with excess reserves or to drain reserves it would do deals with nonbanks to make that happen.

    4. Thank you very much Joe- I owe you one :). And I thank Andre and Brian for his forbearance. And I apologize to Brian for being way off topic here.

  11. "But where do those reserves go to?"

    Well, there are some options:
    1) The reserves may go nowhere. Banks keep the reserves and earn interest on it.
    2) Banks may buy assets, including financial assets, if they believe that those assets are more profitable than keeping reserves on the balance sheet.
    3) Banks may change their credit policy, accepting more costumers than they otherwise would, rising the loans (an asset) - if they find it profitable. Maybe they will reduce the interest rates on loans, maybe they will accepted more risky costumers.

    But I guess everything depends on what causes the excess reserves. Was it some unexpected government spending? Was it some specific government program? Maybe some part of the private sector is desperate to dissave for some reason... Every scenario may have a different answer

  12. Shorter answer:

    1. the level of bank reserves in the aggregate bank sector is set by the central bank;

    2. the mix of reserves (required vs excess within the total level) can change based on bank balance sheet operations in the aggregate bank sector;

    3. in some conditions at least the central bank can force banks to hold excess reserves simply by putting up the level beyond which the bank sector has capacity to dispose of excess reserves via increasing loans and reducing reservable liabilities.

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