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Money multiplier

Hi all,

I was reading a speech from Peter Praet, a Member of the ECB Executive Board about the role of money in a market economy. His speech can be found here: https://www.ecb.europa.eu/press/key/date/2012/html/sp121010.en.html

See a part of his speech below. I find his explanation of the money multiplier a bit confusing.

Cullen, if I understand correctly your main points about the money multiplier are:

1. banks don't simply decide to lend out how much they can, but rather lend out to credit-worthy clients who have demand for credit and

2. the ability of banks to lend is capital-constrained (which depends on regulations) and not reserve constrained.

The second point does not seem to be compatible with what this guy says in his speech, although I might be under that impression due to a wrong interpretation of the concepts outside/inside money.

Can you provide some insight on how to view his comments?


Note that in such a fiat money environment, the outside/inside money distinction remains valid and meaningful. The stock of fiat money can now be thought of as a claim of consumers and investors vis-à-vis the public agency, which is outside the perimeter of the private economy. So, from the standpoint of the private sector, it remains an external, ‘outside’ claim: it is outside money. Also, banks can issue deposits convertible into outside money, which is now the monopolistic prerogative of the regulated public agency, the ‘central bank’. Indeed, in many – though not all – modern-day monetary systems, banks are mandated to hold reserves in outside money in their accounts at the central bank, as a statutory fraction of the total amount of their customers’ deposit accounts. This places a maximum limit on the total amount of loans that commercial banks are allowed to extend through issuance of own liabilities and, by implication, on the volume of inside money that they can legally create.

The ratio between the total amount of inside money and the quantity of outside money is the reciprocal of the reserve ratio – the statutory reserve ratio plus the ratio of banks’ desired excess reserves over deposits – and is sometimes referred to as the money multiplier. 

This is what W.F.M. says.


“But in reality banks lend without reference to their reserve positions, knowing that by the time they have to account for these positions, the funds will be available to them either in the interbank market or from the central bank. The central bank does not have a choice here when there is overall reserve deficit at the end of the accounting period.

Bank lending may be influenced by the price at which they can access reserves. In this sense, you appreciate that the only thing the central bank can do as it provides the reserves to the banks so that they can meet the reserve requirements is to influence the price of funds that the banks lend. It does this because the overnight interest rate basically sets the price of reserves.”


http://bilbo.economicoutlook.net/blog/?p=381&cpage=1 comment-1300



Yes, James is right. Or rather, Bill Mitchell is right in his description.

I'd be careful following the MMT folks (Mitchell) too much on this concept though. They don't view banks as issuing the "real" money. They view govt money as a "net financial asset" and they claim that govt spending creates money and taxes destroy money. This is misleading at best.



"Pragmatic Capitalism is the best website on the Internet. Just trust me. Please?" - Cullen Roche