Wednesday, June 3, 2009

Money multipliers: some falling, some rebounding

David Beckworth at Macro and Other Market Musings calls the crashing of the US money multiplier a "new normal". Normally, the money multiplier will fall during recessions, as loan growth dries up (given that the money base does not offset the contraction); however, the precipitous declines of the money multiplier of late has been anything but normal. This is likewise true of the multipliers in other QE countries (UK and I have argued Japan is up to something), and the ECB (not a QE country, really).

The chart illustrates money multipliers, calculated as the relevant measure of the money stock divided by the monetary base. (Monetary base, or high-powered money, is the currency in circulation plus total reserves held by the banking institution with the central bank.) Global central banks have been easing substantially (effectively to zero in some cases), thereby raising bank reserves. However, banks are reluctant to lend the new liquidity, and multipliers have tumbled in the UK, the US, and the Eurozone.

Japan: The money multiplier remains rather stable.

UK and US: The money multipliers are falling. I find it interesting that they took a turn for the worse amid the announced government bond purchase programs (announcements here and here).

Eurozone: The money multiplier is rebounding, intriguing. This gives some credence to the Eurozone's reluctance to engage in QE at this point in the game.

In the US and the UK, the multipliers are once again crashing. To me, this clearly illustrates how markets are too bearish on inflation - there is no way that the Fed's QE policy (raising the high-powered base by "printing money") will turn into inflationary pressures until this multiplier picks back up on bank lending anew.

Banks are holding (hoarding) $881.6 billion in reserves in April (mostly excess), up from $43.6 billion just a year ago. Until this high-powered money makes its way onto the open market, via the multiplier, it will not turn into money nor inflation.

Inflation is not an imminent threat - perhaps 12 months out, but certainly not right now. As such, bond markets are overly bearish on inflation.

Rebecca Wilder


  1. "Inflation is not an imminent threat - perhaps 12 months out, but certainly not right now. As such, bond markets are overly bearish on inflation."

    But Rebecca, aren't markets supposed to reflect what they perceive to be the common wisdom at least a year out, if not more? If inflation may be imminent a year out, shouldn't the markets be starting to price it in now
    (as indeed they are)? They may be wrong of course, but that's another argument!

  2. Hi Stevie B.

    You make a good point, and clearly, markets should be pricing in inflation across a longer time horizon. I simply don't know what happened over the last 2 weeks to drive up inflation expectations? Perhaps the steepening of the yield curve is not an inflation story? Who knows.


  3. "who knows"

    Precisely! But that doesn't stop us trying to come up with an explanation for now - until we can come up with another one next time!

    Personally think the markets got ahead of themselves deflation-wise, given the determination of the P-T-B (Powers-That-Be) to stop deflation whatever the long-term cost to everyone. All those who have 1st degree burns from the recent and perhaps on-going bond market price implosion are not going to allow themselves to be so severely burnt again, whilst any new buyers will have learnt the lesson of not chasing rates to such absurdly low levels in the future. So the next time the P-T-B try to play the game all over again (by eventually having to raise short-term rates and then having to lower them again), longer rates will not fall anywhere near as much as before, so any turn-around would be much less likely to happen and would be further crushed by rises in raw-resource prices, exacerbated perhaps by cascading declines in the $ and other major currencies in a race to the bottom.

    The sooner the P-T-B realise that you cannot perennially prop up the un-propable-uppable without making things worse in the long term, the sooner we will extracate ourselves from the ongoing morass that is the global economy.

    I could go on, but that's enough of me for now I think!

  4. Boy, did you say it, Stevie!

  5. Of course, millions of dummies accept the deceptive rhetoric and hence acquire their false belief that inflation means an increase in the price of some monolithic price level that purports to measure a fictitious basket of goods.

    Unfortunately, the myth of inflation as meaning 'rising prices ' gets pushed by untold numbers of greater and lesser priests of the Church of Academia, notably economists, none of whom get central banking and money, much less economics.

    Inflation is a process by which Central Bankers attempt to gain economic growth by spurring on new credit growth.

    The chief ways Central Bankers do this include reducing reserve requirement ratios and reducing the interbank lending rate of member banks (in the U.S., the Fed Funds rate).

    Inflation does not work, always, and we're living in one of those times.

    When inflation works, new credit growth rises. As long as output rises in step or if new imports (net exports) makes up for any output deficiency, prices do not rise.

    However, if new credit growth rises and buyers bid on the same output, prices rise.

    For all practical purposes, the money multiplier rate gives a measure of the incidence of risk acceptance.

    A falling money multiplier reveals that cash renters have become more reluctant to rent their cash to others as they perceive the danger of default greater, hence they become unwilling to put at risk their cash.

  6. During Volcker's ERA:

    Money Market Services, Inc., each week surveys sixty individuals who make predictions of what the announcement will be. It is these survey data that we ‘use as our measure of expected money growth.

    Jim Grant of "Grant's Interest Rate Observer" in his book "Money of the Mind"..............

    "The bond market was shocked by a massive downward revision in the basic money supply. The FED had erroneously reported that the M-1, the sum of currency and checking accounts, had risen by $2.8b in the week of Oct. 10…in fact, a big New York bank, Manufacturers Hanover, had miscounted its money, the nation’s money supply had not risen by 2.8 billion in the week after all. It had actually fallen by 200 million".

    If Lewis E. Lehrman (of Rite Aid Drugstore & educated at Yale & Harvard), who is also known for the essay: "Monetary Policy, the Federal Reserve System, and Gold" (published by Morgan Stanley with intro by Barton M. Biggs - head of research there), really understood money & central banking, would then not have lost money on the reporting error.

  7. Grant sent me the essay. Dr. Leland James Pritchard (Ph.D. 1933Chicago, Economics, MS Statistics, Syracuse) commented on it and I returned it with the corrections.

    Wilder: "Monetary base, or high-powered money, is the currency in circulation plus total reserves held by the banking institution with the central bank."

  8. Flawed as the AMBLR figure is (Adjusted Member Bank Legal Reserves), it is still far superior to the Domestic Adjusted Monetary Base (DAMB) figure, which is generally cited. The DAMB figure includes AMBLR plus the volume of currency held by the nonblank public (Milton Friedman’s “high powered money”). Since the public determines its holdings of currency an expansion or contraction of DAMB is neither proof that the Fed intends to follow an expansive, nor a contractive monetary policy. Furthermore any expansion of the non-bank public’s holdings of currency merely changes the composition (but not the total volume) of the money supply. There is a shift out of demand deposits, NOW or ATS accounts into currency. But this shift does reduce Member Bank Legal Reserves by an equal or approximately equal amount.

    Since the member commercial banks operate with no excess legal reserves of consequence since 1942, any expansion of the publics holdings of currency will cause a multiple contraction of bank credit and checking accounts (relative to the increase in currency outflows from the banks) ceteris paribus. To avoid such a contraction the Fed offsets currency withdrawals by open market operations of the buying type. The reverse is true if there is a return flow of currency to the banks.

    Since the trend of the non-bank public’s holdings of currency is up (ever since the 1920’s), return flows are purely seasonal and cannot therefore provide a permanent basis for bank credit and money expansion.

    In our Federal Reserve System, 90 percent of MO (domestic adjusted monetary base) is currency. There is no expansion coefficient for currency. And the currency component of MO is so prominent, and the proportion of legal reserves so negligible (and declining); that to measure the rate-of-change in currency held by the non-bank public, to the rate-of-change in M1 (where 54% is currency), is, yes, to measure currency vs. currency (**** hoc ergo propter hoc); in probability theory and statistics, not a cause and effect relationship.

    Complicating the measurement of the monetary base is the fluctuation in the percentage of foreign currency circulation to domestic currency circulation (estimated at ½ to 2/3 of all U.S. currency). . I.e., the domestic monetary source base equals the monetary source base minus the estimated amount of foreign-held U.S. currency. Inflows and outflows of foreign-held U.S. currency (seldom repatriated) are related to political and price instability, as well as seasonal flows; and all are immeasurable in the short run...

    The “shipments proxy” estimate of foreign-held U.S. currency uses data on the receipts and shipments of currency, by denomination, at the Federal Reserve’s 37 cash offices nationwide (note: > 80 percent of foreign-held U.S. currency are $100.00 bills). Because of its influence on the DAMB, quarterly estimates of foreign-held U.S. currency are reported in the Feds “Flow of Funds Accounts of the United States” & in the BEAs estimates of the net international investment position of the United States.

  9. The volatility of the K-ratio (publics desired ratio of currency to transactions deposits, currency-deposit-ratio), and the volatility in the ratio of foreign-held to domestic U.S. currency, both influence the forecast of the (1) cash drain factor, and (2) the movement of the domestic currency component of the DAMB. This causes unpredictable shifts in the money multiplier (MULT – St. Louis), [sic], for M1 and thus M2.

    The Federal Reserve Bank of Chicago uses legal reserves (“t”-accounts), exclusively, to explain the creation of new money in the booklet “Modern Money Mechanics”. The booklet is a workbook on bank reserves and deposit expansion (changes in bank balance sheets that occur when deposits in banks change as a result of monetary action by the Federal Reserve System – the central bank of the United States). The stated purpose of the booklet is to “describe the basic process of money creation in a "fractional reserve" banking system” - the monetary base has no role in this analyis.

    It is therefore both incorrect in theory and thus inaccurate in practice, to refer the DAMB figure as a monetary base [sic]. The only base for an expansion of total bank credit and the money supply is the volume of legal reserves supplied to the member banks by the Fed in excess of the volume necessary to offset currency outflows from the banking system. The adjusted member bank legal reserve figure is that base.

  10. Hi! Nice toughts, pretty interesting! I am pretty interestin in the trends and changes in the multiplier before and during financial recessions. Do you know any good journals or articles related to that subject? //Joel