Well, it took me 10 years to kill it, but I finally did it. I killed the money multiplier. I kid of course. I didn’t do it on my own.¹ It was a mass murder thanks to many of us. But regular readers will know that I have been on a sort of personal crusade to destroy this narrative for over a decade now. I have to admit. It put up a good fight and it was harder to kill than I would have expected. But it’s officially dead according to the Federal Reserve:
It’s a weird feeling being so happy about murder. But I don’t feel bad because this theory was really bad and deserved to be killed.
I first touched on this defunct idea back in 2009. I then wrote a series of posts about the myth of the money multiplier. It was a central aspect of my thesis for low inflation coming out of the financial crisis and why interest rates were likely to remain low. It was also central to my understanding of QE and why QE was unlikely to cause inflation. In short, flooding the banking system doesn’t cause a multiplier effect in lending or the money supply because banks don’t lend reserves to non-banks in the first place. My paper “Understanding the Modern Monetary System” also focused heavily on this myth and tried to better explain how modern banking actually works.
This was no small matter. The money multiplier was a hugely influential idea that impacted the way many (most?) economists understood the impact of QE and Fed policy following the financial crisis. “Fractional reserve concepts” still muddy the waters here, but it’s nice to see the evolution in ideas and learning. I’ve spent most of my life making mistakes, learning from them and trying to become smarter from it. So this is a big one. Cheers to the Fed and all the economists who updated this material and are pushing for its correct usage.
¹ – While I am happy to give other people some credit here I would like to be known as having been the lead murderer or at least one of the lead murderers. According to my website stats I wrote over 300 articles about the money multiplier in the last 10 years and accumulated 743,000 page views on those articles alone.
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.