rationalskepticism.org

GT2211 wrote:

Blackadder wrote:
1. Very simply put, in the open market, the central bank can purchase government debt. By doing so, it puts money into the account of whoever it bought the debt from and this crates a bank deposit and the multiplier effect takes over and money supply goes up. This is a common tactic used by central banks.


2. The central bank can change the multiplier by changing the reserve requirement. This is done very infrequently as it is disruptive to banks operations if the reserve ratio changes overnight.

I don't think this is quite right.

The role of reserves and money in macroeconomics has a long history. Simple textbook treatments of the money multiplier give the quantity of bank reserves a causal role in determining the quantity of money and bank lending and thus the transmission mechanism of monetary policy. This role results from the assumptions that reserve requirements generate a
direct and tight linkage between money and reserves and that the central bank controls the money supply by adjusting the quantity of reserves through open market operations. Using data from recent decades, we have demonstrated that this simple textbook link is implausible in the United States for a number of reasons. First, when money is measured as M2, only a small
portion of it is reservable and thus only a small portion is linked to the level of reserve balances the Fed provides through open market operations. Second, except for a brief period in the early 1980s, the Fed has traditionally aimed to control the federal funds rate rather than the quantity of reserves. Third, reserve balances are not identical to required reserves, and the federal funds rate is the interest rate in the market for all reserve balances, not just required reserves. Reserve balances are supplied elastically at the target funds rate. Finally, reservable liabilities fund only a small fraction of bank lending and the evidence suggests that they are not the marginal source of funding, either. All of these points are a reflection of the institutional structure of the U.S. banking system and suggest that the textbook role of money is not operative.

While the institutional facts alone provide compelling support for our view, we also demonstrate empirically that the relationships implied by the money multiplier do not exist in the data for the most liquid and well-capitalized banks.Changes in reserves are unrelated to changes in lending, and open market operations do not have a direct impact on lending. We conclude that the textbook treatment of money in the transmission mechanism can be rejected. Specifically, our results indicate that bank loan supply does not respond to changes in monetary policy through a bank lending channel, no matter how we group the banks.

http://www.federalreserve.gov/pubs/feds ... 041pap.pdf

This is an interesting piece of research. Thanks for sharing. Please bear in mind I was trying to explain the textbook definition of money creation. This research shows that the multiplier effect is not as pronounced as most economics textbooks state. I agree and that has a lot to do with the concept of bank liquidity and alternative liabilities that banks can create. Excessive liquidity and stupid credit decisions were in large part what drove the banking system to the edge of oblivion. The central banks had essentially lost control. For the same reasons that their attempts to curb the excesses of the boom years failed, their attempts to inject life back into the economy has largely failed. The answer is liquidity and that is something that central banks have limited ability to control.