Saturday, September 15, 2012

A Note on the Money Multiplier

Judging from the comments to my post: Former Fed Governor: There is a reason EXIT is a four letter word, there is a lot of confusion over how I arrived at a money multiplier of ~100.

In the comments some are pointing to the reserve requirement of 10% to indicate that the multiplier  can not be 100, that it is more in the range of 10. But this fails to recognize that the 10% reserve requirement is only applicable to certain types of accounts such as demand deposits, that other types of accounts have lower requirements and some require zero in terms of reserves, such as nonpersonal time deposits. Here's the Fed chart on it:

Reserve Requirements
Liability TypeRequirement
% of liabilitiesEffective date
Net transaction accounts 1
     $0 to $11.5 million2012-29-11
     More than $11.5 million to $71.0 million3312-29-11
     More than $71.0 million1012-29-11
Nonpersonal time deposits012-27-90
Eurocurrency liabilities012-27-90
Prior to the recent financial crisis, banks became very astute at moving money from the high 10% reserve money accounts into items such as various nonpersonal time deposits. A corporation would, for example, deposit $10 million into a checking account, and its bank, at the end of the day would sweep this into a nonpersonal interest-bearing time deposit. The next day when checks came in against the checking account, the bank would sweep back into the checking account the amount needed to cover the checks, but keeping the remainder in the nonpersonal time deposit account where the reserve requirement, in most cases, is zero.

Thus, the only way to determine the real multiplier is to forget about looking at the reserve requirement for demand deposits and simply look at required reserves and see what multiple of that results in M2 money supply.

The current required reserves are $103 billion. M2 currently stands at $10.39 trillion. This gives you approximately a multiple of 100 times required reserves to reach current M2.

There are also regulatory capital restraints on banks as to how much money they can loan out, but bottom line with $1.5 trillion sitting in excess reserves, there is a lot of firepower that can be moved from excess reserves to required reserves to could explode the money supply.


  1. This is because the fed loans the banks money to loan to the government and buy treasuries. They take that money as tier one capital, lend out all but 10% to the government.

    They then take the 90% that they lent out to the government and because treasury bonds are also tier one capital they loan out 90% of that.

    The other 20% comes from other fed activities like loaning to Europe in exchange for Euros etc.

    Note that they could go around and around in circles almost forever buying treasuries and loaning out again. As far as I can tell (given that I know banks that are doing this) there is no limit and the fed not only doesn't care but is encouraging it.

    1. This is theoretically what can occur, but is not now since the interest rate on excess reserves is twice the t bill rate.

  2. I can tell you that it is happening. I see the day to day banking operations. They're double lending and then parking the rest at the fed (and it appears that others have gotten the hint and may be doing more than double based on daily interchange happening between banks. Right now we're getting about 1% from the Fed (little lower) for excess reserves. A t-bill is still going for more than that even short term ones and given that the money loaned by the fed is at 0% if it's going to buying t-bills (1/2% for other purposes) the difference is even greater. Combine that with going around the loop and parking the delta back at the Fed and they have a perfect scam.

    Of course if interest rates go up for any reason (i.e. Iran closes the straight of Hormuz or just about any other cause, it takes down the banks, the Fed and Treasury in one shot. They literally have created a black swan. Right now the fed is acting very similarly to what happened when gold and silver were fixed price back in the late 1800s and the results are similar, they just have a press to print more money (or shift more 0s) instead of actually having to redeem the silver to gold so no one is noticing yet.

    I'm guessing that Bernake is about to eliminate the interest on reserves held or severely cut it. When that happens the they'll either play the game more, and then lend out after 5 or 6 rounds of flipping government notes which will cause massive money inflation and because there will be so much left at the end the money being lent out will be enormous or they'll pull the funds and lend it directly for fear that the Fed does something about the game playing and confiscates the extra cash. I suspect the Fed can't given that most of the major foreign buyers of treasury debit are out of the market and have been since March but you never know what they'll try considering how obviously clueless (or completely in on the game) they are.