The Monetary Base and Institutional Change

Abstract

Money multiplier research which I have conducted (e.g. – AEJ, 1999; American Economist, 2006) has led me to conclude that institutional changes have rendered monetary base changes virtually irrelevant. Monetary base (MB) changes are now mainly currency changes determined by user demand, and thus, are beyond the control of the Federal Open Market Committee (FOMC). Moreover, changes in the MB have no predictable link to deposit creation. Thus, MB targeting is largely unworkable, and any such targeting would accomplish little in the way of overall monetary control. Changes in currency demand now present an insurmountable problem for those who advocate an MB target. Currency is about 94% of the total MB, and at least one-half of it is estimated to be in foreign hands (Lambert and Stanton, FRB, 2001). Under MB targeting, an unwanted 1% increase in domestic currency demand (now about $7.5B) would decimate reserves by almost 17% (from a current level of about $44B), unless the FOMC ignores the target and offsets the cash drain with defensive open market purchases. Since the advent of sweep accounts in 1994, all of the longrun increases in the MB have been increased currency demand. Sweep accounts have reduced the demand for reserves (from $60.2B in 1994 to $43.9B in 2006) by temporarily moving “idle” M1 balances into savings-type accounts until the funds are needed for transactions (see http://research.stlouisfed.org/aggreg/). As a result, MB changes are now a statistical artifact that mainly reflects changing currency demands. Thus, to advocate an MB target is now equivalent to advocating a target for currency growth. This is a nonsensical target: the domestic currency component is impossible to measure accurately, the significant foreign-held component is Atl Econ J (2008) 36:119–120 DOI 10.1007/s11293-007-9097-3