Our original intention was to explain where we agreed and disagreed with the article by Cullen Roche at “Pragmatic Capitalism” (is there any other kind of capitalism?) titled “The Biggest Myths in Economics”. Instead, while we are still going to refer extensively to the Roche article we will do so within the context of our own list of economics myths. We would have preferred to have kept our list to ten items, but it was a challenge just to restrict it to twelve. Unfortunately, our list is by no means comprehensive.
Myth #1: Banks “lend reserves”
This is the second myth in the Roche article. He is 100% correct when he states:
“…banks don’t make lending decisions based on the quantity of reserves they hold. Banks lend to creditworthy customers who have demand for loans. If there’s no demand for loans it really doesn’t matter whether the bank wants to make loans. Not that it could “lend out” its reserve anyhow. Reserves are held in the interbank system. The only place reserves go is to other banks. In other words, reserves don’t leave the banking system so the entire concept of the money multiplier and banks “lending reserves” is misleading.”
Any analyst who takes a cursory look at historical US bank lending and reserves data will see that there has been no relationship between bank lending and bank reserves for at least the past few decades. We live in hope that the economics textbooks will eventually be updated to reflect this reality, although compared to some of the other errors in the typical economics textbook, this one is minor.
Source Safe Haven