Money, Credit and Bank Behaviour: Need for a New Approach

Abstract

The standard approach, in teaching and textbooks, to explaining the determination of both the supply of money, and the provision of bank credit to the private sector, has been the money multiplier approach, whereby the Central Bank sets the high-powered monetary base, and then the stock of money is a multiple of that. The greatest book on Monetary History ever written, Friedman and Schwartz (1963), Monetary History of the United States, was constructed around this same analytical framework of the money multiplier, whereby M, the money supply, would increase by a large multiple of the change in the high-powered monetary base, H. M=H⋅(1+C/D)(R/D+C/D) Yet when the authorities in the major developed countries attempted to use this relationship to expand the money stock (and bank lending) by force-feeding the banks with base money (H), in the process of Quantitative Easing (QE) in 2009, the prior relationships collapsed.