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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

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.

13 Comments – Post Your Own

#1) On February 14, 2013 at 11:43 AM, Valyooo (33.04) wrote:

I don't get it.  I know banks don't lend out their reserves.  But if the reserve ratio is 5%, that means the bank needs to keep 5 million in cash for every 100 million they create out of thin air.  If they raise the reserve ratio to 10%, they need to keep 10 million in cash for every 100 million they create out of thin air.  In the first example the multiple of loans to reserves is 20, in the second case its 10

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#2) On February 14, 2013 at 12:11 PM, binve (< 20) wrote:


No this is not correct, or at least very imprecise.

In 'normal' times as I pointed out here: , banks have all kinds of means of avoiding minimum reserve requirements (sweeps, windowing, etc.). So this 'constraint' is a non-constraint (which is further compounded by a banking system like Canada which is like ours in virtually every respect except they have no reserve requirements at all. But they don't have a money multplier of 'infinity', they don't have exploding uncontrollable loans, they still settle all interbank payments, etc.).

In 'unusual' times like now there are excess reserves so the 'money multiplier' is much lower than the textbook mulitplier (based on required reserve ratio). 

But there is less bank lending now (or at least a couple  of years ago) than there was before the crisis, depsite the lower 'multiplier'.

The point of this post is to disabuse anyone of the idea the the Money Multiplier Model is a) an accurate depicition of how the banking system lends and its constraints and b) has any predictive power in showing how money is created in the economy.

Just taking one number and dividing by another is not a theory. And when you dig down in the mechanics of that theroy, you see that it is totally fallacious.

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#3) On February 19, 2013 at 11:42 AM, Valyooo (33.04) wrote:

So why do banks accept deposits at all?

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#4) On February 19, 2013 at 12:53 PM, binve (< 20) wrote:

Because deposits are the cheapest way for banks to acquire capital. Banks make loans / take risks based on their equity positions. These capital requirements govern bank lending decisions, and not some fictional money multiplier constraint.

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#5) On February 19, 2013 at 1:20 PM, Mary953 (84.15) wrote:

I don't understand it.  I don't EVER understand it.  You are a super and a very patient person and good friend, but I never ever understand you when you start waxing poetic about anything brushing the world of math or finance.  Some day, I will have a retired husband and I will pass your blogs on to him.  He will be in Heaven reading this and he can explain it all to me. (I am surrounded by men who thoroughly enjoy math - a very good thing entirely.)

Hope Binvette is doing well.  Take her to Phineas and Ferb if it comes to your city.  She will love it.  I have thought a bit about her this last week.  Claire would not have survived the ceiling falling last week had she not left the room a few minutes before it happened. 

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#6) On February 19, 2013 at 3:01 PM, binve (< 20) wrote:

Hey Mary! Thanks, I really appreciate that! Don't worry, I am fairly incomprehensible most of the time :)

Binvette is doing great! She loves preschool. Will do on the Phineas and Feb! That was really a close call on the ceiling, I am glad you and your family are okay but sorry you had to go through that.

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#7) On February 19, 2013 at 6:15 PM, Valyooo (33.04) wrote:

You just said that banks can get around capital requirements, and now you're saying that they need equity positions to make loans.  Which is it?  Those are two opposite statements.


I think it is pretty obvious to everybody that the money multiplier is not fully maxed out at all is just the maximum amount that can be lent per dollar on deposit. $100 in the bank, 10% reserve requirement, they can lend UP TO $1000.

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#8) On February 19, 2013 at 6:30 PM, binve (< 20) wrote:

No, that is not what I said. I said that banks can get around reserve requirements via the 'tricks' listed above. Capital requirements are not the same as reserve requirements.

This is a good thread that talks about deposits in proper light (not from a reserve perspective by from a capital perspective):

I think it is pretty obvious to everybody that the money multiplier is not fully maxed out at all is just the maximum amount that can be lent per dollar on deposit. $100 in the bank, 10% reserve requirement, they can lend UP TO $1000.

No, this is not at all correct. Banks expand the money supply endogenously at the point a loan in originated. This is done indepedent of its reserve position. The Fed will ensure that reserves are supplied after the fact based on the interbank market meeting the Fed Funds rate. Read this post in its entirety:

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#9) On February 20, 2013 at 12:57 PM, Mary953 (84.15) wrote:

you two are making my head hurt.......

What in the world am I doing on a finance-based website?  Oh yeah - trying to survive inflation and prepare for retirement.  (Oh good.  The 3 year old is here.  I can understand her!) 

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#10) On February 21, 2013 at 10:51 AM, Mary953 (84.15) wrote:


I am behind the curve here, but am learning.  I now know what IOER means and that there has been discussion about  a cut in the interest on excess reserves (IOER) rate as an easing option - but that it probably will not happen.  "We expect that Fed officials would hold the same view about cutting the IOER rate today. Finally, as we argued in a recent article, calls for cutting the IOER rate are partly motivated by the premise that banks are holding excess reserves because of an unwillingness to lend. In fact, the level of reserves is controlled entirely by the size and composition of the Fed’s balance sheet, and says nothing about banks’ incentives or their willingness to lend. Cutting the IOER could theoretically stimulate activity by easing financial conditions and boosting loan demand, but it would not affect the quantity of reserves in the banking system."

The above is from  I have also followed your link and subscribed to your market thoughts and analysis.  (in part this was to update my email with you.  Look for mhuff99)

I still have to tackle this in small bits with the awareness that I keep forgetting the stuff that I learn.  It is frustrating to realize that my mom was an Econ professor.  I guess I didn't get that particular ability from her. 

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#11) On February 21, 2013 at 11:51 AM, binve (< 20) wrote:


I here you about being behind the curve. When I first started investigating this stuff, I was way behind the curve myself. It took a lot of reading of thoughts written down by smart generous people for all of this to make sense. 

I agree compleletly with that quote above, cutting IOER will not be 'stimulative' or incentivize any more lending. For exactly the same reason why the money multiplier theory is a myth: the central bank does not control the money supply exogeneously (and controlling M0 has very little to do with M2 and M3) because the monetary transmission mechanism that the money multiplier theory assumes does not exist. Banks control the money supply endogeneously by creating loans. Loans create deposits, and under normal times the reserves required to back those deposits and settle all interbank transactions is provided by the Fed. So under normal times, the Fed doesn't even control M0! It can see the price of reserves (Fed Funds rate) but not the quantity.

Under these ununsual times, the Fed is trying to control the size of M0 (for whatever reason) and the only way it do that is by adding reserves (by buying Treasuries in exchange for reserves via QE) and setting an IOER rate above the FFR. 

But none of this is actually doing much. In fact QE is a 'tax' of sorts because it actually removes interest income that the private sector would be getting from the Treasuries (the Fed sends all Treasury interest payments it receives from the Treasuries back to the Treasury). 

This whole fiasco with QE and increasing the monetary base is because the decisions made at the highest levels of the Fed are based in this mythical Money Multiplier Theory that does not exist.

This same theory has predicted that the 'exploding monetary base will result in massive inflation/hyperfinflation'. And obviously nothing of the sort is happening now. 

I still have to tackle this in small bits with the awareness that I keep forgetting the stuff that I learn.

I hear you, I have the same problem :) All this stuff requires baby steps and lots of re-reading.

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#12) On February 21, 2013 at 12:23 PM, Mary953 (84.15) wrote:

And now I need to go back and research to find out what FFR, M0, M2, and M3 are (Is there an M1 or is that just a rifle?)  I am not even sure that after all this time I understand QE!

A true story from my mom.  She began school at age 38.  One of her classes was Beginning Economics.  She was older than the other students and older than the teacher.  After a week of listening to him talk, she and the rest of the students were totally baffled.  He noted the blank stares of the class and asked if anyone had any questions.  Mom did.  She said, "We don't know what you are talking about - Any of it!  We don't understand the terms you are using, so how can we understand what you are telling us about them."  He asked for a show of hands to see if anyone else felt that way.  The entire class raised their hands.  He started over the next class by handing out vocabulary sheets and explaining the terms.  Mom came out of his class as an economics major.  It turned out she had been looking for someone to put into words what was natural for her.  He did.  I will never have a PhD as she did eventually, but that doesn't mean I cannot start at the beginning and learn a great deal.

Thanks for being one of my very patient teachers! (Patient - manifesting forbearance under provocation or strain: steadfast  yep - sounds like you and a few others.  Anchak and Porte come to mind)

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#13) On February 21, 2013 at 12:57 PM, binve (< 20) wrote:

FFR = Fed Funds Rate
M0 = Monetary Base
M1 = slightly larger monetary aggregate (seldom discussed).
M2 = larger monetary aggregate. Many economists will refer to this measure when discussing the money supply
M3 = broadest measure of money, but the Fed stopped keeping track of M3 years ago. There are a few websites that keep track of it unofficially

I agree, vocabularly and terminology is extremely important. It is exceptionally true in accounting (as I know you are aware) and economics would be better served by being more accurate with its terminology / take a cue from accounting, because they are so related and dependent.

That is a great story about your mom! And I am happy to be patient! Thanks for the compliment.

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