The Money Multiplier Doesn't Exist
February 14, 2013
– Comments (13)
Banks don't lend reserves.
This has been explained many times by many people (here is one from me). Banks create money (loans) out of thin air, these loans go on to create deposits within the banking system, which is matched by a reserve injection by the Fed so that the demand for reserves meets its target interest rate (the Fed Funds rate). The Fed sets the price, not the quanity, of reserves during 'normal' times. But now with the banking system having excess reserves, the demand for those reserves go to the IOER rate (they would go to ~0 on the overnight network because the system has more reserves than need to fill settlement needs and RRs, but since the Fed pays IOER the demand goes to that rate).
But this excess reserve postion has not spurred new bank lending because banks don't make loans based on ther reserve positions (see link above). They make loans to perceived credit-worthy customers based on their own capital requirements. Banking is a business of making money off of credit spreads.
It is important to understand banking operations because monetary policy decisions affect them most directly (and banks are one of the biggest components of the economy; outstanding bank debt is much higher than outstanding government debt). So any monetary policy decisions will be 'funneled' banks. And monetary policy is one of the levers that drives the economy.
Yet, we continue to see economists and commenters hold on to this fully discredited Money Multiplier Model (Myth) of how the banking system works.
----------------------------------------
Wednesday, February 13, 2013
The Money Multiplier Doesn't Exist
Posted by Joshua Wojnilower
http://bubblesandbusts.blogspot.com/2013/02/the-money-multiplier-doesnt-exist.html
The Myth Of The Money Multiplierby Barkley Rosser @ EconoSpeak
That Fed control over the money supply has become a phantom has been quite clear since the Minsky moment in 2008, with the Fed massively expanding its balance sheet without much resulting increase in measured money supply. This of course has made a hash of all the people ranting about the Fed "printing money," which presumably will lead to hyperinflation any minute (eeek!). But the deeper story that some of us were unaware of is that apparently this disjuncture happened a long time ago. Even so, one of our number pointed out that official Fed literature and even many Fed employees still sell the reserve base story tied to a money multiplier to the public, just as one continues to find it in the textbooks, But apparently most of them know better, and the money multiplier became a myth a long time ago.
Woj’s Thoughts - Rosser refers to a paper from the Federal Reserve Board’s Finance and Economics Discussion Series that was the source of a recent Quote of the Week Money, Reserves, and the Transmission of Monetary Policy: Does the Money Multiplier Exist? (by Seth B. Carpenter and Selva Demiralp, May 2010):
Changes in reserves are unrelated to changes in lending, and open market operations do not have a direct impact on lending. We conclude that the textbook treatment of money in the transmission mechanism can be rejected.
As I noted in that post:
If staff members at the Federal Reserve are aware of the money multiplier myth than surely Bernanke and the other board members have heard the arguments. Unfortunately most mainstream economists, especially monetarists, continue to promote monetary stimulus as if the old regime still persists.
Fortunately the economics professors at James Madison stumbled across this paper and were convinced of its conclusion. Hopefully they will join a minority of current economists in training future economists to recognize the money multiplier does not exist.
RSS Headlines
Fool UK