Here’s an elegant solution to the problem of the US’s missing money multiplier.
Just declare it doesn’t exist. Or at least, not as we know it.
That’s just what Seth B. Carpenter and Selva Demiralp are arguing in a new Federal Reserve working paper. It’s not necessarily a new argument, by any means, but it’s one that seems to be gaining traction.
The suggestion is that the US money multiplier has not just temporarily gone walkies, but actually doesn’t exist in its textbook form. Here’s Carpenter and Demiralp:
Reserve balances have recently increased dramatically, going from around $15 billion in July 2007 to over $788 billion in December 2008. Despite this increase by a factor of 50, no similar increase in any measure of money, as suggested by the multiplier, could be found. Hence, while the actual multiplier was about twice the theoretical multiplier in 2003, it was about 1/50th of the theoretical multiplier in 2008. Considering other measures of money, the monetary base, the narrowest definition of money, doubled over that period while M2 grew by only 8½ percent.
Casual empirical evidence points away from a standard money multiplier and away from a story in which monetary policy has a direct effect on broader monetary aggregates . . .
And after testing some of their theories (about 50 pages of results here) they conclude:
Since 2008, the Federal Reserve has supplied an enormous quantity of reserve balances relative to historical levels as a result of a set of nontraditional policy actions. These actions were taken to stabilize short-term funding markets and to provide additional monetary policy stimulus at a time when the federal funds rate was at its effective lower bound. The question arises whether or not this unprecedented rise in reserve balances ought to lead to a sharp rise in money and lending. The results in this paper suggest that the quantity of reserve balances itself is not likely to trigger a rapid increase in lending. To be sure, the low level of interest rates could stimulate demand for loans and lead to increased lending, but the narrow, textbook money multiplier does not appear to be a useful means of assessing the implications of monetary policy for future money growth or bank lending.
The implication is that the Fed may well be even more parabolic than was thought when it comes to encouraging banks to start lending again, or stimulating the real economy. Increasing bank reserves via QE was meant to encourage banks to lend as they try to re-establish their target ratio of reserves to their balance sheet. We referred to it in early 2009 as “basic money multiplier stuff.”
The Fed itself, in case you’re wondering, seemed enamoured of monetary transmissions when it began its unconventional policies in late 2008. Back then it was so concerned with the link between money and monetary policy that it wrote about “divorcing” the two — something which came to pass when it began paying interest on reserves that year. Anyway, the over-arching point is that if the multiplier doesn’t exist, then the QE process won’t work, and the Fed will be left with few other options.
The low interest rate one mentioned in the paper, incidentally, certainly isn’t guaranteed to work. There’s already been some discussion, that ultra low rates are actually bad in terms of bank lending.
Does the Fed have any other ideas?
Money multiplier – missing feared dead – Billy blog
Reserves and reservations – Japan’s QE redux – FT Alphaville
The parabolic Fed: divorcing monetary policy from money – FT Alphaville