Money, Reserves, and the Transmission of Monetary Policy: Does the Money Multiplier Exist?

62 Pages Posted: 27 Jul 2011

See all articles by Seth B. Carpenter

Seth B. Carpenter

Federal Reserve Board - Department of Monetary Affairs

Selva Demiralp

Koc University - Department of Economics

Date Written: May 1, 2010

Abstract

With the use of nontraditional policy tools, the level of reserve balances has risen significantly in the United States since 2007. Before the financial crisis, reserve balances were roughly $20 billion whereas the level has risen well past $1 trillion. The effect of reserve balances in simple macroeconomic models often comes through the money multiplier, affecting the money supply and the amount of bank lending in the economy. Most models currently used for macroeconomic policy analysis, however, either exclude money or model money demand as entirely endogenous, thus precluding any causal role for reserves and money. Nevertheless, some academic research and many textbooks continue to use the money multiplier concept in discussions of money. We explore the institutional structure of the transmission mechanism beginning with open market operations through to money and loans. We then undertake empirical analysis of the relationship among reserve balances, money, and bank lending. We use aggregate as well as bank-level data in a VAR framework and document that the mechanism does not work through the standard multiplier model or the bank lending channel. In particular, if the level of reserve balances is expected to have an impact on the economy, it seems unlikely that a standard multiplier story will explain the effect.

Keywords: Money mulitplier, reserves

JEL Classification: E51, E52

Suggested Citation

Carpenter, Seth B. and Demiralp, Selva, Money, Reserves, and the Transmission of Monetary Policy: Does the Money Multiplier Exist? (May 1, 2010). FEDS Working Paper No. 2010-41. Available at SSRN: https://ssrn.com/abstract=1895509 or http://dx.doi.org/10.2139/ssrn.1895509

Seth B. Carpenter (Contact Author)

Federal Reserve Board - Department of Monetary Affairs ( email )

20th and C Streets, NW
Mailstop 60
Washington, DC 20551
United States
202-452-2385 (Phone)
202-452-2301 (Fax)

Selva Demiralp

Koc University - Department of Economics ( email )

Rumeli Feneri Yolu
Sariyer 80910 Istanbul
Turkey
+212 338 1842 (Phone)

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