What would happen if the central bank cancelled its loans to indebted banks?

hatrickpatrick · 24-04-2012 09:49PM #1

This has probably been discussed already but I've been thinking about this over the last while:

Since money initially gets into circulation via a loan from a central bank, when a credit crunch / banking recession such as this one occurs, what would happen if the central bank cancelled the debts from those banks, thereby preventing a banking collapse while avoiding a never ending debt cycle of issuing another loan to repay the first?

As en emergency measure, what would happen? Would it cause the same kind of chaos that simply printing more money would supposedly cause? My instinct is telling me it wouldn't, since the issue in these cases is not a lack of supply or demand, but a technical problem in the circulation of money which is jamming up the gears, if you will.

So what would happen if this was tried? Anyone been into this idea before?

GUIGuy · 25-04-2012 03:11PM

That central bank & country might get slack/sanctions from the other central banks in the Euro Group. I'm guessing here but as part of the creation of the Euro each national central bank promised to behave... ie not just print money. So the Germans might think why abondon the hard won DM if the Greeks can just print extra Euro. If one does it then the whole system breaks down.

So now you have no central bank doing QE. The Fed, BOE & BOJ have all done huge QE (by modern standards) and it has only resulted in relatively light inflation. The ECB can't do it as its not in its remit... it can loan out but that money must be repaid... no 'new money' is created.

Same goes for the national central banks. The CBI will effectively burn all the money the irish taxpayer pays back to it, as to do otherwise (or debt cancelation) would effectively increase the actual money supply.

I'm not saying that is should/shouldn't happen - but the central banks are in a bind... they are tied into a pact that holds back inflation when we could probably do with some , we're in a defaltionally spiral at the moment. People are hoarding any cash they can because they are worried and holding back on purchases because they know it could well get cheaper tomorrow... that's bad for everyone.

hatrickpatrick · 25-04-2012 03:49PM

GUIGuy wrote: »

That central bank & country might get slack/sanctions from the other central banks in the Euro Group. I'm guessing here but as part of the creation of the Euro each national central bank promised to behave... ie not just print money. So the Germans might think why abondon the hard won DM if the Greeks can just print extra Euro. If one does it then the whole system breaks down.

So now you have no central bank doing QE. The Fed, BOE & BOJ have all done huge QE (by modern standards) and it has only resulted in relatively light inflation. The ECB can't do it as its not in its remit... it can loan out but that money must be repaid... no 'new money' is created.

Same goes for the national central banks. The CBI will effectively burn all the money the irish taxpayer pays back to it, as to do otherwise (or debt cancelation) would effectively increase the actual money supply.

I'm not saying that is should/shouldn't happen - but the central banks are in a bind... they are tied into a pact that holds back inflation when we could probably do with some , we're in a defaltionally spiral at the moment. People are hoarding any cash they can because they are worried and holding back on purchases because they know it could well get cheaper tomorrow... that's bad for everyone.

I wasn't talking about national central banks, I mean the central bank with the power to actually create currency, which in this case would be the ECB.
Economically, what would happen? If the ECB simply cancelled its loans to Anglo for instance?

I realize in normal circumstances this would be presumed to cause hyperinflation, but we're not in anything like normal circumstances at the moment, and I'm just wondering what would actually happen, ecnomically speaking, if the ECB or Fed in the US did something like this.

It creates money by lending it out as a loan, what would happen if it subsequently wrote off those loans?

What would happen if the central bank cancelled its loans to indebted banks?

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