Decomposing US Money Supply Changes since the Financial Crisis

Richard Robinson,Marwan El Nasser

doi:10.3390/ijfs1020032

Abstract

In response to the financial crisis of 2008, the Federal Reserve radically increased the monetary base. Banks responded by increasing excess reserves rather than increasing bank loans, and the public responded with a substantial flight to liquidity in the form of currency and demand deposits. As a result, the money-supply multipliers substantially decreased, so that the actual money supply measures grew more moderately than the base. The sustained multiplier-collapse spawned reexamination of monetary versus fiscal theories of price-level determination. This paper, however, presents decompositions of the money-multiplier collapse into changes in the currency-to-deposit ratios, and changes in the reserve-to-deposit ratio. By doing so, possible near-term increases in the multipliers are simulated so that the possibility of either full or partial restoration to their pre-crisis levels is assessed. Policy possibilities for controlling the money supply over various horizons follow. This analysis illustrates the Federal Reserve’s exit dilemma that results from its financial-crisis policy.

Highlights

One conventional view of Federal Reserve policy during the post 2008 financial crisis is that its open-market operations were merely “pushing on the string of a liquidity trap.” the FedInt
In order to indicate the extent of the problem, and the tight path the Fed must follow to manage and avoid this inflation, below we provide simulations of changes in the money-multiplier, and the monetary base
The money multiplier and money supply simulations presented above show some startling evidence concerning future monetary policy, i.e., if the Fed does not liquidate at least some of its holdings of Treasuries and MBS, and provided that bank loans do return to normal levels, it is highly likely that substantial growth rates of M1 will result

Summary

Introduction

One conventional view of Federal Reserve (the Fed) policy during the post 2008 financial crisis is that its open-market operations were merely “pushing on the string of a liquidity trap.” the Fed. This latter policy involved purchasing very large amounts of targeted securities: i.e., mortgage-backed securities, agency debt securities (which allowed agencies to further support the mortgage market), commercial paper, money-market mutual fund securities, and medium and longer-term Treasury bonds This quantitative easing involved the Fed directly purchasing one of the risky or less-liquid assets from financial markets, and paying for these purchases by either liquidating its portfolio of T-bills or increasing the monetary base. In light of this decomposition, possible near-term increases in the multiplier are simulated so that the possibility of full or partial restoration to its pre-crisis level is assessed This examination includes explorations of the options the Fed has for handling the excess reserves, and simulations of the money supply expansion process. This simulation analysis further illustrates the Fed’s exit dilemma from its financial-crisis policy

Options for the Fed’s Exit Strategy

Multiplier Decomposition

Data Set Analyzed

Implications for Monetary Policy

Simulated Monetary Results under Various Fed Options

Conclusions