Money Multiplier Research Articles

Money Multiplier Under Reserve Option Mechanism

This paper introduces a generalized money (M2) multiplier formula to the literature for a monetary system with Reserve Option Mechanism (ROM). Various features of the proposed multiplier are then explored using monthly Turkish data during the decade 2005 to 2015. We report a step increase in the magnitude and a slight upward adjustment in the long-run trend of the multiplier with the adoption of ROM. We provide evidence for substantial change in the seasonal pattern of the multiplier, cash ratio, required and excess reserves under ROM. We show that money (M2) multiplier is less volatile in a monetary system with ROM and discuss the subsequent stabilizing influence of more predictable multiplier on the foreign exchange market.

Socio-economic Impact of Tobacco Cultivation on Dalit Agricultural Laborers

This article is based on an in-depth study of the socio-economic changes experienced by agricultural laborers as a result of tobacco cultivation. Two villages in the Prakasam district of Andhra Pradesh, India—one where tobacco is extensively grown (Karavadi) and the other where it is not (Veerabhadrapuram) are studied. What emerges from the study is that tobacco cultivation has not only acted as a money multiplier, but has brought about a very high degree of social awareness among the hitherto so-called untouchables (now termed Dalits) in this district. They have become highly conscious of their political and social rights for improving themselves. In this process, some of the practices like untouchability, social exclusion and engagement in traditional occupations have been shaken at their roots.

Impact of Money Supply on India's Balance of Payments during 2000–2010

This paper attempts to analyze the effect of RBIs and commercial banks’ credit (loans extended) to the government and to the commercial sector on India's balance of payments. Only “below the line” items are considered that is only inflows in and outflows from India of foreign exchange are considered while studying the impact on India's balance of payments during 2000–2010. This approach is basically the monetary approach to the balance of payments which was developed in 1960s and 1970s at Chicago school and at IMF. Whether its flexible or fixed exchange rate, according to the monetary approach difference in the demand for money and the supply of money leads to the changein inflows of foreign exchange. According to the monetary approach excess supply of money over the demand for money leads to outflow of foreign exchange and excess demand for money than the supply of money in the domestic country leads to inflows of foreign exchange. This approach is basically based on price – specie – flow mechanism of David Hume and it is also based on G. Cassel's purchasing power parity theory”. Credit extended by RBI and the commercial banks to the government and to the commercial sector and also money multiplier have been taken as a supply of money. Interest rates, price level and real GDP growth have been considered as demand for money factors. Interest rates and demand for money for money have inverse relation that is as interest rate goes up demand for money reduces. And price level, GDP have positive relation with demand for money i.e. as real GDP and the price level go up demand for money also increases. Monetary approach is valid under the full employment situation. This study finds that monetary approach is not valid in India where the country is characterized with unemployment situation.

Loan as a Durable Good and Bank Indirect-Tax Incidence

This paper maintains that the durable-goods character of loans enables the forward shift of bank indirect taxes a la Coase (1972), increasing thereby the money multiplier and reducing the equity-lending ratio regardless bank industry structure. Consequently, policymakers may use such taxes countercyclically if, of course, the need for depositor insurance is not exaggerated evoking upon the problems of asymmetric information accompanying lending. Also, the “standard” proposition that the ability to shift indirect taxation forward depends negatively on the size of the elasticity of loan demand, is confirmed here, too. The low elasticity of loan demand is related with relationship banking, contemplating thereby that the mix “bank indirect tax-relationship banking” may prove to be critical for capital accumulation and growth depending on the dissemination of such banking. A zero-bank-profit policy is proposed as a stabilization policy beyond the countercyclical manipulation of the tax.

Bank deposits, loans and redistribution of wealth in the case of an already adopted theoretical opinion

Money creation with fractional reserve banking is an already accepted theoretical position, designated as an operation after that the society is not richer but the economy is more liquid, because there is more money in circulation. Banks, by lending a portion of their deposits cause a process of creating of new deposits and thus increase the total money supply. Money, by definition, is a means for the exchange of goods and services, but after analysing the creation of money in the process of monetary multiplication, the question arises to which consequences this concept will lead. Therefore the theory of the money multiplier will be analysed in detail from the aspect of money demand, management of money supply and possible redistribution of wealth due to the existence of additional deposits.

The inflation impact of bonds versus money financing of fiscal deficits in India: some theoretical and empirical perspectives

It is generally believed that Government’s fiscal deficits, only when financed by central bank’s new money creation, will be inflationary in nature. In this paper, we demonstrate using a simplified comparative static model based on aggregate money supply, accounting that the inflation impact of fiscal deficits financed through bonds representing commercial banks’ credit to the Government can be similar to conventional monetized fiscal deficits. Our framework does not require stable money multiplier and other simplified assumptions pertaining to base money supply. We provide empirical evidence on fiscal deficits significantly affecting inverted broad money demand and thereby supporting our theoretical perspective. The findings emerging from the paper have implications for monetary and fiscal policies.

Banks as Accelerators of the Circulation of Money

The money multiplier approach asserts that banks are unique in that they implement a creation of money, while the finance approach regards banking institutions as financial intermediaries among others. In retrospect, Cantillon’s Essai stands between these two extreme approaches. It both challenges the money multiplier approach and grants to banks a significant monetary role. The aim of the paper is to clarify Cantillon’s theoretical propositions on bank issuing of debts convertible on demand into money at face value and to explore further the proposition according to which banks contribute to accelerating the circulation of money.

Expansionary Monetary Policy at the Federal Reserve in the 1920s

This paper analyzes the two main divergent interpretations of Federal Reserve monetary policy in the 1920s, the expansionary view described by Rothbard (2008a [1963]) and earlier “Austrian” writers, and the contractionary view most notably held by Friedman and Schwartz (1993 [1963]) and later monetary historians. This paper argues in line with the former that the Federal Reserve engaged in expansionary monetary policy during the 1920s, as opposed to the gold sterilization view of the latter. The main rationale for this argument is that the increase in the money supply was driven by the increase in the money multiplier and total bank reserves, both of which were caused primarily by Fed policy (i.e., a decrease in reserve requirements and an increase in controlled reserves, respectively). Showing that this expansion did in fact occur provides the first step in supporting an Austrian Business Cycle Theory (ABCT) interpretation of the 1920s, namely that the Federal Reserve created a credit fueled boom that led to the Great Depression, although this is not pursued in the paper.

The Federal Reserve's Exit Strategy: Looming Inflation or Controllable Overhang?

Many economists and economic commentators fear that the Federal Reserve does not have an adequate exit strategy from the quantitative easing that took place during the financial crisis. Its bloated balance sheet has allegedly left a looming monetary overhang that the Fed will not be able to manage once the economy returns to normal. Interest rates will rise, banks will increase their loans, reserve ratios will fall, and money multipliers will rise, all unleashing very high inflation. Caught off guard, the Fed will neither accurately foresee nor easily offset this process. I argue that this fear is exaggerated. The Fed has four new or expanded tools?loans from the Treasury, reverse repurchase agreements, interest on reserves, and term deposits?with which it can restrain inflation without resorting to traditional open market operations. Indeed, a greater danger is that the Fed's exit strategy will involve no significant reduction in its balance sheet.

Quantitative easing and the loan to collateral value ratio

We study optimal monetary policy in a New Keynesian model at the zero bound interest rate where households use cash alongside house equity borrowing to conduct transactions. The amount of borrowing is limited by a collateral constraint. When either the loan to value ratio declines or house prices fall, we observe a decrease in the money multiplier. We argue that the central bank should respond to the fall in the money multiplier and therefore to the reduction in house prices or the loan to collateral value ratio. We also find that optimal monetary policy generates a large and persistent fall in the money multiplier in response to the drop in the loan to collateral value ratio.

The breakdown of the money multiplier at the zero lower bound

Unconventional monetary policy intends to influence the economy at the zero lower bound. However, this policy becomes less effective due to a diminishing money multiplier in a liquidity trap. We show that this creates an extreme low interest rate, low multiplier regime. This insight contributes to the literature, which shows there is uncertainty over the effects of unconventional monetary policy and the precise channel through which it works.

Pomoc ohroženým bankám - teorie, realita a měnové dopady

The recent financial crisis has significantly modified the approach to helping troubled banks. The traditional role of the central bank has shifted toward non-credit forms of assistance, provided mainly by the state, and even toward assisting insolvent banks. State assistance - directly or through specialized institutions - mainly concerned banks too big to fail, i.e. systemically important banks. State aid should be forthcoming only once funds available from shareholders, owners of subordinated debt and uninsured depositors have been exhausted. Credit by a central bank should be granted only to temporarily illiquid banks. Primarily as this credit assistance can have significant monetary implications, in as much as it leads to the growth of reserves in the banking system. The impact on the economy then depends primarily on the credit activity of commercial banks. The author compares theory against practice and, using the U.S. and the EMU as an example, analyses the monetary impact using the development of money multipliers.

It Is Private, Not Public Finances that Are Out of Whack

Abstract When the private sector as a whole is forced into debt minimization following the bursting of a debt-financed bubble, the money multiplier turns negative at the margin and government borrowing and spending become essential in maintaining both the GDP and money supply. With unborrowed private savings languishing in the financial system, the market also encourages government borrowing in the form of low bond yields which is a natural corrective mechanism of an economy suffering from balance sheet recession. In the eurozone, this corrective mechanism fails because of the ease of capital flight between government bond markets within the currency zone.

Empirical Evidence for the Endogeneity of the Money Supply in the United States from 1971-2008

Standard economic textbooks portray the money supply as exogenous. Most of these use a money multiplier framework to demonstrate the causal role of the monetary base in determining commercial bank lending and overall economic activity. In contrast, endogenous money theories attribute the determination of commercial bank lending and overall economic activity to the demand for credit, not the supply of money. In these theories, the demand for credit determines the supply of money, which banks create ex nihilo. We use updated Granger-causality tests to analyze quarterly U.S. data from 1959 to 2008 and find evidence that changes in commercial bank lending cause changes in both the monetary base and nominal income. Our results provide further support for the endogenous money views that the money supply has always been endogenous and that credit plays an important role in the money supply process. Endogenous money theories therefore provide a strong foundation for analyzing how credit and monetary policy affect overall economic activity.

Multiplicador monetario y dinero electrónico. Creación de dinero a partir de depósitos y efectivo electrónico

In this paper, the hypothetical role of the electronic money in the overall money supply using the money multiplier is analyzed. Assuming a replacement or purchase of traditional cash or deposits by electronic money, and considering two types of electronic money, electronic money deposits and electronic cash, and different forms of issuance as regards the requirement of different reserve ratios for the electronic money issued, the purpose is to analyze the influence of the issuance of electronic money on the system of money creation by commercial banks and central banks.

An Empirical Analysis of Money Supply Process in Nepal

This paper examines the money supply process in Nepal empirically on the basis of mainstream and Post-Keynesian theoretical perspectives for both pre and post-liberalization period covering the sample period of 1965/66-2009/10. The relative contribution of different components of money supply has been computed and the money supply as well as money multiplier function has been estimated. Empirical results show that disposable high powered money is found to be a major contributor to the change in monetary aggregates without any significant structural break. However, the degree of controllability of high powered money is not strong, and neither CRR nor Bank Rate has been effective monetary policy tools so far. Open market operation is found statistically significant only at 10 percent level of significance to influence disposable high powered money. On the other hand, money multipliers are affected by currency ratio, time deposits ratio and excess reserve ratio, but not by CRR. On the other hand, Granger causality based test of Post-Keynesian hypothesis reveals that money supply endogeniety cannot be ruled out. Hence, monetary policy framework needs to be changed accordingly and OMO should be strengthened further.

Basil J. Moore's Horizontalists and Verticalists: an appraisal 25 years later

<section class="abstract"> In 1988 Basil Moore published his book <em>Horizontalists and Verticalists: The Macroeconomics of Credit Money</em>, which this year celebrates its 25th birthday. We discuss this book from today's perspective, and in particular whether Moore's main assertions have been validated or rejected by the development of central bank practice and academic monetary economics. We find that the book has impressively stood the test of time and, despite part of textbook economics still insisting on the money multiplier as an explanation for the money supply, it is not much of an exaggeration to say that we have all become ‘Horizontalists’ in the last 25 years. </section>

Money Supply and Economic Activity in South Africa – the Relationship Updated To 2011

This paper reconsiders the relationship between measures of money and measures of economic activity in the South African economy and the role of the Reserve Bank in moderating South African economic cycles. By using data for the past twenty years, the earlier analysis is updated and reassessed so that it is possible to see if the fundamental relationships between money, credit and economic activity have changed and whether the role of the Reserve Bank in managing economic activity has become more pivotal and constructive. One important difference noted is that broadly defined money (M3) does better in explaining economic activity between 2000 and 2011 than narrowly defined money. The opposite is true for the earlier sub-periods. The paper utilises a model of the money supply process to explain why the relationship between narrowly and broadly defined money changed after the year 2000 with regulations that encouraged the banks to reduce their demands for cash leading to an increase in the money multiplier. The paper concludes that the ability of the SA Reserve Bank to moderate the money and bank credit cycles, utilising interest rates as the primary instrument of monetary policy, remains as elusive as ever.

The Macroeconomic Outlook and Liability Management Strateegies

The current macroeconomic outlook presents a duality: On the one hand, Federal Reserve forecasters believe that short-term rates will remain excessively low (0-25 basis points) for a prolonged time period, possibly extending into 2015. On the other hand, the balance sheet of the Federal Reserve has nearly tripled ($850 billion versus approximately $3 trillion) since the onset of the great contraction of 2008-2009, suggesting skyrocketing future inflation accompanied by skyrocketing interest rates. The main reasons behind this very low interest rate environment are twofold: first, the unemployment rate is significantly higher than its steady state level (approximately 8% versus 5%), and second inflation is not significantly higher than its policy level of about 2%-2.5% p.a. The Federal Reserve follows some version of the frequently-cited Taylor rule, or framework, which suggests that the Fed Funds rate equals the long-run real rate (about 2%) plus the steady-state inflation rate (approximately 2% to 2.5%) and a weighted average of the GDP gap and the inflation gap. Though there are many interpretations of the Taylor rule, most economists would agree that the current environment implies a very low or even a negative Fed Funds rate that will remain as such until the unemployment rate reaches its full-employment level. Under normal circumstances such an increase in base (or high-powered) money would have resulted in significant levels of inflation. Currently, however, because the money multiplier has declined significantly due to the contraction, M1 and M2 have not grown as fast as high-powered money. And, heretofore inflation has not materialized. Nonetheless, global economic history suggests that inflation may hit suddenly and violently. And, this is the current macroeconomic duality: very low interest rates projecting into the distant future offset by high-levels of inflation risk. This duality intuitively suggests that an optimal funding strategy should consist of short term borrowings (to exploit the low short-term rates) coupled with long-term borrowings (to hedge against rising inflation and interest rates). In this paper, I empirically demonstrate that a barbell funding strategy is indeed on the efficient frontier, and most efficient frontier strategies consist of the barbell with episodic inclusions of the 5-Year, particularly under increased liquidity or funding risk eventualities. Once we delineate the efficient frontier, the CFO can choose the optimal fixed versus floating mix based on his pain tolerance for declines in Earnings per Share (EPS) given likely moves in short term rates.

Money Creation: Death of the Money Multiplier

It persists in part of the literature that there are two monetary policy models: the monetary base-focused model (aka the money multiplier model/strict money-rule model) and the interest rate-focused model. The former only exists in theory because its implementation (for brief periods in a few countries) had severe consequences in terms of interest rate volatility (a major input in business decision-making). The interest rate-focused model relies on interest rates, which are under the control of the central bank, being the restraining factor in the demand for bank loans which, when satisfied by the banks, leads to simultaneous deposit (money) creation. It is still alleged by some that the two models differ in terms of how money is created. This is not so, as money creation is the outcome of net new bank lending in both (only endogenous money creation exists). The difference between the two models is that the one is applied while the other is not. It is time to say goodbye to the money multiplier.