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Monday, May 15, 2023

Money Multiplier Mudslinging

There was a small kerfuffle on Twitter created by Olivier Blanchard regarding the money multiplier in the next version of his textbook.

Skanda Amarnath gave a reaction which matches my view, but I just want to add a couple of extra comments.

The first question is: why teach the money multiplier in the first place? At this point, I think it is just a question of unthinking tradition, as well as the lack of reliable quantitative “laws” in undergraduate economics. You can only torture moving two lines on a figure so far in exam questions, the money multiplier gives another question that can be solved with an equation on an exam.

The other angle is that it is part of mainstream ideological indoctrination. The money multiplier fits in with the barter exchange model where everything is determined by central bank policy. If bank loans are always magically straining at the “reserve limit” the private sector has no capacity to create credit, and so everything depends upon the central bank creating new reserves. This then creates the ideologically conditioning to accept more “advanced” models where private credit growth is non-existent as a base case model. In practice, most mainstream economists know that private credit growth is not under the direct control of the central bank — but they want to think of that as a deviation from the ideal economy, not the baseline.

Although I have done my best to make this sound bad, I am more ambivalent on this subject that one might expect. I am supposed to do a podcast interview this week (to be released later, will inform closer to that date) where I expect the discussions of the weaknesses of mainstream macro to come up. I think the lessons to be drawn are not what is usually stated, mainly because nobody is happy with the lesson.

The key point is that Blanchard is not backing away from the multiplier because it is incorrect, rather he is adding one or more epicycles to downplay its usefulness (Skanda Amarnath uses a Scooby Doo metaphor instead of epicycles.) In any system where the central bank cares about the level of interest rates in the economy — all the time in the real world — reserve creation is a reaction to demand from banks (making the money multiplier meaningless).

To most people with a casual acquaintance to the history of science, “adding epicycles” is bad. However, that value judgement is based on the premise that the point of academia is to seek knowledge. The ugly reality is that the point of academia is to produce journal articles — whether or not people even read those articles.

Think about it. Mainstream economists have been teaching undergraduates a laughably incorrect theory for decades, yet once they finally meet enough resistance, they just add an epicycle and retcon the entire concept out of existence. Importantly, there is no need to cite anyone who pointed out problems with the concept. It is very hard to dislodge such an adaptable belief system.

The belief in Progress underlies a lot of attitudes in modern societies. We need to adapt our thinking to accept that Progress is largely a myth.

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(c) Brian Romanchuk 2023

1 comment:

  1. I have 2 degrees in economics, but I’ve worked for a depository institution for 15+ years on the analytical side. To this day I can’t forget a conversation I had with the person who managed our payment (clearing) operations… I had been meet with Joan to better understand how payments were processed – payments are a point of data of interest. In our conversation Joan said she always felt uncomfortable that “we’re running on air”. I immediately thought Joan was a Gold Bug, but as I learned more I realized that was not what she meant. Joan was NOT AN ECONOMIST, but she knew how the system worked. She was not invested in an IDEOLOGY, but she knew and had more insight into how the system worked.

    Henry Ford - “It is well enough that people of the nation do not understand our banking and monetary system, for if they did, I believe there would be a revolution before tomorrow morning.”

    Economist just aren’t any smarter than the average person, and they still haven’t figure out that they KNOW NOTHING about how banking and finance actually works. They waste their time with epicycles so that they don’t have to acknowledge that they really don’t get it or that maybe they were wrong.

    As someone who was trained as an economist, it took visits with Joan to realize what I had been taught about “banking” was false!

    Old stats saying... "Liars can figure and figures can lie". The Money Multiplier is, or historically had been, an ex-post accounting fact number, but it doesn’t mean that’s how banking works.


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