More inside/outside money endogeneity confusion
I was surprised by a Twitter discussion yesterday that linked to this good post by David Beckworth. As you can guess, the topic once again involved the endogeneity of money. Beckworth’s answer to an interview question was:
My answer was that inside money creation–money created by banks and other financial firms–is endogenous, but the Fed shapes in an important way the macroeconomic environment in which money gets created.
David is right. But what I do find surprising is that his interviewer could ask such question as “do you believe that money is endogenously created?”
Let’s clarify something: the fractional reserve banking/money multiplier model necessarily implies endogenous creation of bank inside money. It describes how banks multiply the money supply from a small amount of externally-supplied reserves. If this isn’t endogenous creation, I have no idea what this is. I don’t think anybody who accepts that model ever denied that fact.
The recent debate wasn’t about whether bank inside money was endogenously created but about whether or not the monetary base (i.e. outside money, or bank reserves) was also endogenously created. This is not at all the same thing and has very different implications altogether.
If the monetary base is endogenously created, the central bank cannot control the money supply, as MMTers and some post-Keynesians believe. I believe this is not the case, as highlighted in my various post (see here, here and here for examples).
However, if bank inside money is endogenously created and outside money exogenously created, this can only mean one thing: banks’ inside money creation ability is exogenously constrained by the amount of outside money in the system (though other factors also come into play).
This has always been the essence of the fractional reserve banking/money multiplier model. Model that has been severely misinterpreted recently, as Scott Sumner pointed out in a very recent post:
He [David Glasner] seems to believe multiplier proponents viewed it as a constant, which is clearly not true. Rather they argued the multiplier depends on the behavior of banks and the public, and varies with changes in nominal interest rates, banking instability, etc.
I can’t say how much I agree with Scott here, and this is exactly what I said in a recent post:
In their attempt to attack the money multiplier theory, they mistakenly say that the theory assumes a constant ratio of broad money to base money. There is nothing more wrong. What the money multiplier does is to demonstrate the maximum possible expansion of broad money on top of the monetary base. The theory does not state that banks will always, at all times, thrive to achieve this maximum expansion. I still find surreal that so many clever people cannot seem to understand the difference between ‘potentially can’ and ‘always does’.
A system in which there would be no money multiplier would effectively be a 100%-reserve banking system.
What’s interesting is that many proponents of the ‘uselessness’ of the money multiplier seem to have tone down their criticisms recently. Frances Coppola went from “the money multiplier is dead” to “it is improperly taught” (my paraphrasing)…
PS: when in my various posts I refer to (and say that I don’t believe in) the endogeneity of money, I refer to outside money/monetary base/high-powered money/reserves/whatever you want to call it, as I take inside money endogeneity for granted (with constraints, as already explained).