Money Creation: Death of the Money Multiplier

Abstract

It persists in part of the literature that there are two monetary policy models: the monetary base-focused model (aka the money multiplier model/strict money-rule model) and the interest rate-focused model. The former only exists in theory because its implementation (for brief periods in a few countries) had severe consequences in terms of interest rate volatility (a major input in business decision-making). The interest rate-focused model relies on interest rates, which are under the control of the central bank, being the restraining factor in the demand for bank loans which, when satisfied by the banks, leads to simultaneous deposit (money) creation. It is still alleged by some that the two models differ in terms of how money is created. This is not so, as money creation is the outcome of net new bank lending in both (only endogenous money creation exists). The difference between the two models is that the one is applied while the other is not. It is time to say goodbye to the money multiplier.

Keywords: Money, endogenous money, exogenous money, central banking, banking, interest rates, monetary policy

JEL Classification: A22, E42, E51, E52, G21