Computational Complexity Analysis of Credit Creation v Austrian School of Economics reserve analysis

The computational complexity analysis of credit creation presented on this blog is an analysis of the dynamics of the reserves generated in the credit creation process. There are four disjoint and complete (taken together) classes that capture the dynamics of the reserves: full reserve banking, fractional reserve banking, no reserve banking and depleting reserve banking. Briefly, lending with loan to deposit ratio of 0% results in full reserve banking, lending with loan to deposit ratio of more than 0% and less than 100% results in fractional reserves banking, lending with loan to deposit ratio equal 100% results in no reserves banking and lending with loan to deposit ratio of greater than 100% results in depleting reserves banking. The Austrian School of Economics gives the static analysis of the reserves: if a ratio of reserves to deposits is 100% it is full reserve banking, otherwise it is fractional reserve banking.

The relationship between static and dynamic analyses

A static full reserve banking is a result of dynamic full reserve banking credit creation process. A static fractional reserve banking is a result of the dynamics of either fractional reserve banking or no reserve banking or depleting reserve banking. Therefore the static analysis is less fine-grained. Importantly static analysis of reserves by Austrian School of Economics completely misses the pyramid creation aspect of the credit creation process when loan to deposit ratio is greater than 100% (i.e. it is only the case of depleting reserve banking).

This note was prompted by a number of comments from academic economists who considered the reserves analysis on this blog isomorphic to Austrian School of Economics'. Hence they missed the key point of distinguishing a static aspect of reserves from their dynamics.