Keen Disappointment

At Business Spectator, Steve Keen considers The myth of the money multiplier. He begins by reviewing "The standard story about how banks create money, and how reserves work". Of that story, Keen writes

to anyone who’s done empirical research, it’s a myth.

The most recent proof of this is in an excellent discussion paper from Federal Reserve economists Carpenter and Demiralp, entitled “Money, Reserves, and the Transmission of Monetary Policy: Does the Money Multiplier Exist?”. The first clue that it doesn’t exist is given by their abstract, which notes that, “before the financial crisis, reserve balances were roughly $20 billion”. If the textbook model were correct, the total stock of money in the USA would be $200 billion, versus the multi-trillion dollar level of even a narrow definition of the money stock. As the authors note, this makes a mockery of the textbook “Money Multiplier” model

The impression arising from Keen's numbers is that the standard story must be wrong. The numbers are way off, so the money multiplier story must be wrong. Okay, except for one thing: It is Keen's story that is wrong.

If the reserve requirement is "say 10 percent" as in Keen's example, the $20 billion reserve balance is 10% of $200 billion money, and everything works out fine. But the money supply is much, much more than $200 billion, and it doesn't work with the 10% number. So what is wrong?

The 10% is wrong. Keen uses 10% as an example in the setup. But in the denouement he lets us think that 10% is a valid number, and he takes advantage of our confusion to convince us that the money multiplier story is false.

It is Keen's 10% that is false. Only a very small part of U.S. money must abide by the 10% requirement. For most of that money, there is no reserve requirement at all.

If I have it right, for money in circulation the reserve requirement is 10%. And for money in savings the reserve requirement is zero. A reserve requirement of zero means there is no limit to how much bank money can be issued upon each dollar. With a reserve requirement of zero, the money multiplier could easily produce multi-trillion dollars of money. As, in fact, it has.

But I could be wrong. Keen lays out the requirement differently in his post. He says the reserve requirement is "10 per cent of household deposits only in the USA – there is no reserve requirement for corporate deposits". But again, if there is no reserve requirement on some of the money, then there is no limit to how much bank money can be issued upon each dollar of that money.

Either way, the result is that we end up with trillions of dollars of debt, trillions of dollars of money, and an infinitesimal, tiny fraction of the money in reserve.

The impression Keen gives with his numbers is that the story is wrong because the numbers don't work. The numbers do work. The reserve requirement is not universally applied, but the numbers work. The standard story is not wrong.

Steve Keen wants to convince his readers, even if he has to fudge the story to do it. I am frankly disappointed in him.

Oh, and I searched the PDF for the words "mockery" and "mock". The PDF does not contain those words. It is Keen who says "this makes a mockery of the textbook 'Money Multiplier' model". Not the Federal Reserve guys.