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Economists Already Understood the Money Multiplier (not)

Simon Wren Lewis isn’t impressed by the recent Bank of England paper explaining endogenous money and why the money multiplier is a myth.  He claims that the textbook multiplier is an issue that students misinterpret and central banks shouldn’t bother writing articles about because mainstream economists already understand all of this stuff (duh):

“As a result, some students end up believing that banks just lend out deposits and that the central bank controls the money supply via a multiplier. And a central bank feels it needs to write an article pointing out that this is not so. That I think is a bit shocking.”

I know for a fact that there are plenty of economists who understand the concept of endogenous money.  But I also know that there has been widespread misinformation about this topic during the last 5 years because I’ve spent an excessive amount of time refuting so much of it.  So Simon is wrong to imply that it is only “students” who have misinterpreted this concept of banks “lending out” or multiplying reserves.  Take for instance, some of these people who you just might recognize:

“But as the economy recovers, banks should find more opportunities to lend out their reserves.”

–  Ben Bernanke, Former Fed Chairman, 2009

“Commercial banks are required to hold reserves equal to a share of their checkable deposits. Since reserves in excess of the required amount did not earn any interest from the Fed before 2008, commercial banks had an incentive to lend to households and businesses until the resulting growth of deposits used up all of those excess reserves.”

– Martin Feldstein, Harvard Economics Professor, 2013

“So far all that new money [reserves] has not caused inflation because banks have sat on much of it rather than lending it out and stimulating expenditures.”

– Tyler Cowen, Professor of Economics at George Mason, 2009

– “[The Fed knows] that if there is an opportunity cost from these massive reserves they’ve injected into the system, we are going to have a hyperinflation.”

– Nobel Prize Winner Eugene Fama on why the Fed is paying interest on Reserves, 2012

“the Fed is paying the banks interest not to lend out the money, but to hold it within the Fed in what are called excess reserves.”

– Laurence Kotlikoff, Boston University Economics Professor, 2013

“Notice that “excess reserves” are historically very close to zero. This reflects the tendency (assumed in textbook discussions of “open market operations”) for commercial banks to quickly lend out any reserves they have, over and above their legally required minimum.”

–  Robert Murphy, Mises Institute, 2011

“In normal times, banks don’t want excess reserves, which yield them no profit. So they quickly lend out any idle funds they receive. “

–  Alan Blinder, Princeton University Economics Professor, 2009

“given sufficient time, [banks] will make enough new loans until they are once again reserve constrained. The expansion of money, given an increase in the monetary base, is inevitable, and will ultimately result in higher inflation and interest rates.”

–  Art Laffer, Former Reagan Economic Advisor, 2009

“First of all, any individual bank does, in fact, have to lend out the money it receives in deposits. Bank loan officers can’t just issue checks out of thin air”

–  Paul Krugman, Nobel Prize Winner & Princeton University Economics Professor, 2012

“Ohanian points out that the Fed has done a lot already, having increased bank reserves from $40 billion to $900 billion. But this liquidity injection was not what it seems — indeed, if it was, we’d now have hyperinflation. In reality, the Fed completely neutralized the injection by starting a new policy of paying interest on reserves, causing banks to simply hoard these “excess reserves,” instead of lending them out. The money never made it out into the economy, so it did not stimulate demand.”

–  Scott Sumner, professor of Economics at Bentley University, 2009

None of the above comments are representative of an understanding of endogenous money and the concepts discussed by the Bank of England.  And these are some of the absolutely most influential people in the field of economics.  So Simon Wren-Lewis is clearly downplaying the widespread failure of the economics profession to understand endogenous money.

Clearly, this isn’t just a problem for “students”.  It’s a problem that starts at the very highest levels of economics and has led to some very bad predictions in the last 5 years, the continued use of dysfunctional economic models and continued misunderstandings.  The sooner we all recognize it, fix the problem and move on the sooner we can begin helping students and future generations to better understand our economic world so they can frame the thinking and policies that better serve the world of the future.  Of course, that requires that many of the current teachers and economists first admit fault and second digest these concepts.  Unfortunately, if the recent response to the BOE’s research is any sign, it looks like we’re not exactly moving in the right direction there….


The Myth of the Money Multiplier

The Bank of England Debunks the Money Multiplier

Bank Lending is Primarily a Demand Side Issue

The Money Multiplier Doesn’t Exist Outside the Zero Lower Bound Either

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