Monthly Archives: July 2016

Why the money multiplier remains so low

George Selgin’s latest monetary policy primer was a very good explanation of the money multiplier in fractional reserve banking systems. He also suggested that a number of factors may be affecting the current surprisingly low level of the multiplier; a fact that prompted a number of endogenous money theorists to (wrongly) assert that the multiplier was ‘dead’.

In this post, I wish to elaborate on the reasons behind the low multiplier. And those reasons are, in my view, related to banking mechanics and regulatory dynamics.

Let’s first start with a little bit of history to put things in perspective. Some time ago, and following one of my blog posts on the topic, Levi Russel from the Farmer Hayek blog – who is much better than I am at manipulating FRED data – kindly sent me the following chart representing the M2 multiplier (‘MM’) since 1920:

More on the Short-Run Macroeconomics of Brexit

Prof. Krugman(in NYT) takes a all together different view. And amazingly defends it.

On Thursday I weighed in on the short-term effects of Brexit, questioning the near-universal premise among economists that it will be a major negative shock to demand. I wasn’t trying to be counterintuitive for the sake of sounding clever, let alone trying to defend the Brexiteers. I was just genuinely puzzled about where this consensus came from, given that nothing in standard macroeconomic models says that a policy bad for the economy’s long-run supply side necessarily hurts its short-run demand side. And I worried that the apparent consensus among economists was in some sense political rather than analytical: free trade good, breaking from Europe bad, therefore you don’t have to be careful in your arguments about exactly why it’s bad.

I’ve received several thoughtful responses from economists I respect, all making a particular argument about the effects of Brexit-induced uncertainty. It goes like this: right now, firms don’t know how closely Britain will be tied to Europe, so it makes sense for them to postpone investments until the situation clarifies.

This is an interesting and defensible argument — basically, that the unclear shape of Brexit creates an option value to waiting. But I have three questions about it.

First, is this really the argument underlying all of these dire post-Brexit forecasts? My guess is that very few people reading news reports, or even briefing papers, about Brexit are hearing this; what they’re getting is much closer to the notion that uncertainty = increased probability of bad things. That is, this argument is a lot more nuanced and subtle than anything I previously heard in this discussion.

Second, doesn’t this argument imply a later investment boom once the uncertainty is resolved in either direction? That is, once Prime Minster Farage and President Le Pen have engineered the demise of the EU, there’s no reason to wait, and all the pent-up investment comes roaring back, right? But I haven’t heard anyone arguing that the contractionary effect of Brexit will be followed by a compensating boom once things settle down.

Third, doesn’t this argument suggest essentially the same effects from any policy negotiation whose end result isn’t known? Why don’t we say that the possibilities of TPP or TTIP are contractionary, because firms have an incentive to postpone investment decisions until they know whether these agreements actually happen? Somehow, though I’ve never heard anyone argue for the depressing effects of pending trade liberalization.

Again, I’m not trying to defend Brexit. But I worry that the urge to condemn it has led to a lowering of intellectual standards.

And let me also say that the narrative of disaster is coloring some (not all) financial reporting. On the whole, the market reaction looks pretty muted to me. It’s not just stocks: European bond spreads are about where they were a month ago. True, globally, rates are considerably lower; but we aren’t seeing the kind of financial disruption so widely predicted. Yet headlines about turmoil are everywhere.

Could I be wrong about all of this? Of course! But everyone really should ask where the consensus about Brexit macro is coming from.