Several readers have written to me asking me to comment on a recent paper that the New York Federal Reserve released as a Staff Report (May 2011) – A Note on Bank Lending in Times of Large Bank Reserves. Apparently, there is an impression that the federal reserve economists might be seeing the light a bit about the banking system and the way economists think about it. The reason that some readers have concluded that is because the substantive conclusion of the paper is that credit expansion is independent of the level of banking reserves held at the central bank. This conclusion is totally consistent with Modern Monetary Theory (MMT) but is at odds with the standard mainstream macroeconomic view (as taught in textbooks) that relies on the money multiplier to draw a (spurious) connection between bank reserves and the money supply. As you will see – my advice is to be very careful when reading such papers – they are not what they seem. The FRNY paper reaches the correct conclusion using erroneous theory which they partition as a special case arising from the extreme circumstances surrounding the crisis. Even in defining their “model” as a special case, they employ flawed logic. It is a case of being beware of the wolf in sheep’s clothing.