The money multiplier is alive
Remember, just a few years ago when a number of economic bloggers tried to assure us, based on some misunderstandings, that banks didn’t lend out reserves and that the ‘money multiplier was dead’?
I wrote several posts explaining why those views were wrong, from debunking endogenous money theory, to highlighting that a low multiplier did not imply that it, and the basis of fractional reserve theory, was ‘dead’.
Even within the economic community that still believed in the money multiplier, there were highly unrealistic (and pessimistic) expectations: high (if not hyper) inflation would strike within a few years we were being told, as the first round of quantitative easing was announced. Of course those views were also wrong: the banking system cannot immediately adjust to a large injection of reserves; even absent interest on excess reserves, it takes decades for new reserves to expand the money supply as lending opportunities are limited at a given point in time.
A few years later, it is time for those claims to face scrutiny. So let’s take a look at what really happened to the US banking system.
This is the M2 multiplier:
As already pointed out several years ago, the multiplier is low; much lower than it used to be between 1980 and 2009. But it is not unusual and this pattern already happened during the Great Depression. See below:
Similarly to the post-Depression years, the multiplier is now increasing again.
Let’s zoom in:
Since the end of QE3, the M2 multiplier in the US has increased from 2.9 to 3.7 in barely more than three years. This actually represents a much faster expansion than that followed the Great Depression: between 1940 and 1950, it increased from 2.5 to 3.5, and from 1950 to 1960, it increased from 3.5 to 4.2.
Unsurprisingly, this increase occurred as excess reserves finally started to decline sustainably:
As we all know, following the 1950s, the multiplier eventually went on increasing for a couple more decades, reaching highs during the stagflation of the 1970s and early 1980s. Unless a new major crisis strikes, it is likely that our multiplier will follow the same trajectory, although I am a little worried about the rapid pace at which it is currently increasing. One thing is certain: the money multiplier is alive and well.