Politically, maybe, but not economically unless (as you note) they don’t have enough assets to make an escape strategy.
But they have other methods of controlling inflation, like paying a higher IoER or mandating higher reserve requirements for banks.
This is an utterly meaningless distinction. It could not be more off the point. You have said so yourself: our wealth is ultimately about putting people back to work.
If there are more dollars out there bouncing around quickly, instead of privately-owned low-velocity assets, those dollars will seek out investment and consumption opportunities. Those new dollars will not want to sit still. With inflation expectations, there’s the hot potato effect which drives the process. Never forget velocity! Moving dollars will raise asset prices, buy up idle resources, seek out the surplus of productive capacity now available, and put people to work. Money is the medium of exchange. It circulates through the economy in a way no other private asset can possibly manage.
And of course, you stop supplying this money when your nominal spending gets back on track.
I didn’t say it was advisable. I said it was possible. I said speaking of money as a function of government spending is incorrect, mistaking what normally happens with what must happen.
One of the chief effects of the central bank’s power is that the assets are never fundamentally worth what they pay for them. Never.
The central bank pays “market price”, sure, but that’s a market price conditional on the fact that this one special player in the game can buy whatever the hell they want. The latest rounds of QE have had the central bank buy up assets at prices that banks are willing to sell those assets, but the price itself is not a Platonic ideal. Already calculated into the price is the idea that the central bank can buy effectively anything. The yield curve has been flattening lately. Why? Some say it’s because the Fed has been making noise about shifting tactics, no longer increasing the size of its balance sheet but changing the composition of its balance sheet, specifically, stocking up on more long-term bonds.
The very fact that there is a player capable of doing this on such a massive scale has already pushed up the price of these bonds (and pushed down their yields). The US 10-year is near 2% right now, gobsmackingly low, not based on the Fed actively intervening in the market, but quite likely based in part on the expectation of future intervention. Their power to make money gives them the power to shape expectations. Thus setting expectations is one of their most important tools. This has always been true. Gold didn’t used to be worth $20 an ounce because that was its fundamental value. Gold was worth $20 an ounce because they dictated that it be so.
The key now is changing expectations, even if we lose the fundamental values of the assets it purchases.
First, I haven’t exactly argued that there is a money multiplier, at least not in the Wikipedia sense. (On double-checking the article, I see Wikipedia now has an entry on the “loans first” model, which is good, because that model happens to be correct most of the time. Loans do generally (but not always!) come before reserves with the way banks are currently set up.)
But your final clause there is a doozy. It seems equivalent to saying that the central bank has no power on its own, which is absolutely incorrect. The Fed has oodles of power, all by its lonesome, with no need for any help from Treasury.
There is a limit to bank lending based on the supply of base available (or naturally, the expectation of what will be available in the future) regardless of how credit-worthy the borrowers are. New money is extremely powerful in the short-term. If there were no limit, then the Fed raising interest rates, i.e. sucking monetary base out of the system by selling assets (and, as always, the expectation that they will do so), would have no real effects. That is entirely contrary to the functioning of the real economy. Central banks are powerful. They can push economies into recession with buttons on their computers. And they have done so in the past. The Volcker recessions were caused by the Fed deliberately in order to rein in inflation. And they succeeded.
When people come to realize the implications of the loans-first model of the money multiplier, they tend to drop the whole edifice, as if the central bank has no power at all, as if supplying and retracting the base (or the expectation to do so) is not so important. I have seen the total rejection several times before, but I can never understand it. It makes no sense whatsoever.
The ability to supply new base money is an amazing power.
There is little direct mathematical relationship here. But why would there be?
Look at that Swiss link I posted. Go back and genuinely look at that graph at the bottom, the Swiss/Euro exchange rate. And understand something about that: The Swiss bank did not immediately start supply francs in exchange for euros automatically. They simply said they would do whatever it takes to get the rate back above 120. If you look at their money creation, you will not see a perfectly correlated spike in the aftermath of their press conference. They had utterly no need to create so much base immediately. The exchange markets, armed with clear expectations from the central bank in the aftermath of a credible policy announcement, did the job all by themselves.
Eventually, the markets could decide that Swiss inflation is creeping up high enough that the central bank will no longer be willing to expand its balance sheet without limit to keep the exchange rate at 120. The bank might have to take some pains to get the target where it wants. Or, if the macro variables dictate, their central bank could even change its mind and let the exchange rate drop. But for now, the markets fully believe their willingness and ability to meet their target, and that allowed them to reach their target by merely saying some words.
You’re focusing on total deposit liabilities (fairly close to the M2 money supply). You can see the lines of your graph start out close, then get further and further apart, as if the money multiplier were magically expanded. That seems strange only if you believe the naive version of the multiplier. If you look at the M3 (or the shadow M, if it could actually be measured), you would see an even larger discrepancy, even more quickly growing with more volatility, between the supply of base money and total money stock. That is to say, you’d see an even bigger “money multiplier”.
As what happens with any bank panic, you’d see those broader money supplies vanish in the wind, contract massively, in the wake of the bank run – the latest case being the run on repo and the collapse of many of those derivatives markets. The money is lent, the debt is created, far out of proportion to the productive capacity of the economy, and thus also out of proportion with the base needed to support it. The debt is called back, repo lenders demand redemptions, or larger haircuts on the collateral (equivalent to deposit withdrawals with a standard commercial bank). If it happens all at once, that means there is a bank run, and the bank doesn’t have enough money. The bank fails, the money supply collapses, the multiplier drops again.
The primary reason that the M2 didn’t collapse just as magnificently as the broader money supplies is deposit insurance.
But it’s not the “multiplier” per se that’s important. Central banks keep on eye on the money supplies, but they don’t care as much as you might think about multipliers. FRED doesn’t even keep track of the M2 multiplier (although it does have M1). As far as the Fed is concerned, banks can create as much money as they can, given their expectations about future central bank action. That’s not the central bank’s primary concern. The central bank wants financial stability, but at core they are trying to target macro variables.
Unfortunately, the Europeans chose the wrong variable.
The central bank obviously doesn’t work through a strict multiplier. It can’t. The legal enforcement of deposit reserves, at least in the US, isn’t nearly strict enough for that to work. And rightly so. The Fed works through a subtler mechanism based on expectations about macro variables. When the Fed was supplying enough money to allow nominal spending to increase at around 5% annually, the economy was good. The “multiplier” was growing, but that wasn’t the important part of the graph. The important part was the slow but steady increase in base, the Fed’s promise to offer more liquidity when it was needed. They didn’t need to keep up with the M2, they just needed to provide the expectation that they would be able to do so, if necessary, if they could also keep the big macro variables like inflation in place.
The macro variables are where it’s at. It was only when the Fed allowed the biggest drop in nominal spending since the Great Depression that we quite unsurprisingly had the biggest economic downturn since the Great Depression. They failed to pay attention to the right macro variable.
Contracts are typically written in nominal terms. People are typically paid in nominal wages. A huge chunk of our debt burden is a nominal burden. These are all nominal frictions, especially downward frictions. These numbers seriously don’t want to move downward. Wages are sticky, debt relief requires costly and time-consuming bankruptcies. When the total nominal output of our economy decreases, the friction from these burdens becomes incredibly severe. The solution is to relieve these nominal burdens and increase aggregate demand. The lack of credit-worthy borrowers is right now not a cause, but a result of these nominal burdens. If we were on the right macro track, our banking crises would be correspondingly less severe.
The most efficient way to relieve these nominal burdens is to create more money. Our traffic light for this money creation should be the future trend of nominal spending.
I’m on the verge of typing myself out here. I really don’t have anything more to say on this. Any more, and I’d be writing a macro/monetary policy textbook, and that would be rather excessive. If you have specific questions, I’ll try to answer them. But the main point you should take from this is that money is extremely powerful, despite whatever misconceptions might be floating out there about the money multiplier process. All of those high level money supplies come down, in the end, to a promise to back back monetary base on demand. If there is an expectation that there will be less money out there, and that it will be circulating less quickly through the economy, then lending will naturally contract and the money supplies fall. That’s one reason (among others) why the money supplies are unhelpful targets, as the original monetarists learned to their dismay.
You have to think about the economy itself, not just bank deposits.