I have been looking around on this site for an answer to such a question, but I cannot a definite one. By time deposit I mean this: The depositor puts $100 in the bank, but cannot touch it for say 5 years. During that period, the bank loans out the $100. After 5 years, assuming the bank did not make bad loans, the depositor will be paid back the $100 plus a portion of the intererest. Under fractional reserve banking demand deposits, the debtor and the depositor both have claims to the same amount of money. Under 100% reserves, that would not be the case, would it? For debtors could never use the money in demand deposits and depositors could not use the money in their time deposits. The demand and loan side would be separate.
I have read others who say 100% reserves would still result in inflation of the money supply because when the time deposit money is loaned out, debtors will deposit the loaned money in their bank, and it would then be loaned out. There are two options for deposit. If the debtor puts it in a demand account, which makes more sense to me, it can't be loaned out again, so I don't see how money can be created. If it is put in a time deposit (perhaps to cancel out interest payments?) I still don't see how money isc reated, because the debtor will not longer have access to that money. The same money would be loaned out again, and nothing would be created. If the loan was bad, money wont be created, the bank will just be less profitable.
Exactly how would time deposits function like demand deposits in creating money and continuing some form of the business cycle? Do they at all?
tcostel: Do they at all?
Do they at all?
No, they don't. Your thinking is correct.
Money is not created by the use of time deposits. Imagine an economy of 100 gold coins. Let's say all money is currently not in a bank. Bob receives a payment of 20 gold coins and puts them in a time-deposit at a bank. This is the first deposit ever. No money is created in the act of depositing it. No money is being created by virtue of residing on deposit at the bank. The bank then loans out the 20 gold coins to Alice. However, there is the same number of coins as there ever was... 100. No money was created by virtue of loaning the gold coins. If Alice puts the gold coins back in another time-deposit, the same process can be repeated. At no point will there be more than 100 gold coins.
We can add banknotes to the thought-experiment to make it more complex but as long as we require each banknote to be backed by a gold coin, the system will remain non-inflationary.
Clayton -
Here is my confusion though. Banks create money by loaning out deposits made by other loans. Say you have a time deposit of $1000. The bank then loans that to someone else, who puts that $1,000 back in a time deposit (assuming they would do this, which is not impossible). Time deposits are counted in the money supply, so because there are currently 2 $1,000 time deposits, the supply would be $2,000. Is this simply an error in how money supply is calculated (it seems like double counting to me) or am I doing something wrong?
I notice that only one person will ever be using the $1,000 at once, but on the budgets of the bank wont it read that they have $2,000 invested in time deposits?
Just view time deposits as loans. Alice can lend her car to Bob who can further lend it to Chris. There are 2 car loans but still just 1 car.
I think your confusion arises from the idea that banks loan deposits.. banks do not loan deposits, deposits are put into reserves. Banks create new money against promissory notes, and they are allowed to make usually around 10 times their reserve amounts.
This article explains it http://www.thecactusland.com/2011/05/moral-hazard-of-modern-banking-how.html
Banks create money by loaning out deposits made by other loans.
Only if those loans were funded by demand deposits. To be more exact, if the maturity of the time-deposit is shorter than the maturity of the loan which it funds, then the loan is logically equivalent to money creation. If the loan is funded by a deposit whose maturity is as long or longer than the maturity of the loan (i.e. a 1-year loan funded by a 1-year or 2-year time deposit), then the loan is not inflationary.