Ed Dolan posts helpfully<\/a> to Economonitor on the more realistic approach suggested by the theory of endogenous money. In particular, I took note of the following passage, which brings up a point that I wrote about recently:<\/p>\n\u00a0\u201cFormally, a model that includes a minimum reserve ratio or target plus unlimited access to borrowed reserves would not violate the multiplier model, in the sense that at any given time, the money stock would be equal to the multiplier times the sum of borrowed and non-borrowed reserves. However, the multiplier would have no functional effect, since the availability of reserves would no longer act as a constraint on the money supply. Economists describe such a situation as one of endogenous money, by which they mean that the quantity of money is determined from the inside by the behavior of banks and their customers, not from the outside by the central bank.\u201d <\/i><\/p>\n
In this simplified setting, the constant known as the \u201cmoney multiplier\u201d becomes the \u201ccredit divisor,\u201d a concept defined in a short article I wrote recently for the forthcoming Elgar volume Encyclopedia of Central Banking. <\/i><\/p>\n
Using the divisor D, instead of<\/p>\n
bank reserves\u00a0\u00d7\u00a0 M = money,<\/p>\n
one can write<\/p>\n
credit\/D = bank reserves.<\/p>\n
The equation reflects a theory in which causality runs from left to right, reflecting the endogeneity of reserves.<\/p>\n
Indeed, the divisor is far more realistic as a model of the money-creation process than the money multiplier. The collapsing money multiplier in the figure in Dolan’s post corresponds to a rapidly rising credit divisor.<\/p>\n
The post also points out that after loan demand, \u201cthe second constraint is bank capital.\u201d<\/i> The post notes that when this constraint is binding, the idea of a \u201creserve constraint\u201d is still more irrelevant. Also, a profitable<\/i> and solvent<\/em> bank that wishes to expand its lending can usually increase its capital by retaining earnings or by other moves, as Marc Lavoie and others have pointed out in the academic literature. Moreover, Lavoie observes that a commercial bank having difficulty raising capital might be able get the central bank to purchase its shares in some countries.\u00a0 Lavoie\u2019s account can be found in his fairly comprehensive essay, \u201cA Primer on Endogenous Money,\u201d in Modern Theories of Money,<\/i> edited by Louis-Philippe Rochon and Sergio Rossi, Edward Elgar, 2003.<\/p>\nFrom a policy perspective, a fast-growing stock of money is not generally a “cause” of inflation, though it can be an effect of rising prices or economic activity. (Of course, interest rates that were low enough long enough could cause inflation in a situation in which there was a lack of unused productive capacity.) Central banks cannot fix the growth rate of money to achieve a desired inflation rate, by setting the growth rate of bank reserves. For, as the concept of the credit divisor illustrates, the latter are also endogenous in a modern banking system.<\/p>\n","protected":false},"excerpt":{"rendered":"
Regarding spurious policy arguments about \u201cexcessive growth of the money stock\u201d: Ed Dolan posts helpfully to Economonitor on the more realistic approach suggested by the theory of endogenous money. In particular, I took note of the following passage, which brings up a point that I wrote about recently: \u00a0\u201cFormally, a model that includes a minimum […]<\/p>\n","protected":false},"author":193,"featured_media":0,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[36,112,40],"tags":[243,340],"class_list":["post-9520","post","type-post","status-publish","format-standard","hentry","category-book-review","category-modern-monetary-theory","category-monetary-policy","tag-endogenous-money","tag-monetary-policy-2"],"jetpack_featured_media_url":"","_links":{"self":[{"href":"https:\/\/blogs.bard.edu\/multiplier-effect\/wp-json\/wp\/v2\/posts\/9520","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/blogs.bard.edu\/multiplier-effect\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/blogs.bard.edu\/multiplier-effect\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/blogs.bard.edu\/multiplier-effect\/wp-json\/wp\/v2\/users\/193"}],"replies":[{"embeddable":true,"href":"https:\/\/blogs.bard.edu\/multiplier-effect\/wp-json\/wp\/v2\/comments?post=9520"}],"version-history":[{"count":8,"href":"https:\/\/blogs.bard.edu\/multiplier-effect\/wp-json\/wp\/v2\/posts\/9520\/revisions"}],"predecessor-version":[{"id":9528,"href":"https:\/\/blogs.bard.edu\/multiplier-effect\/wp-json\/wp\/v2\/posts\/9520\/revisions\/9528"}],"wp:attachment":[{"href":"https:\/\/blogs.bard.edu\/multiplier-effect\/wp-json\/wp\/v2\/media?parent=9520"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/blogs.bard.edu\/multiplier-effect\/wp-json\/wp\/v2\/categories?post=9520"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/blogs.bard.edu\/multiplier-effect\/wp-json\/wp\/v2\/tags?post=9520"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}