What do you mean by money multiplier

The fairy tale of the money creation multiplier

"Once upon a time there was a dwarf who claimed he could do magic. He was a central banker and could make gold out of straw, create money out of nothing with a commercially available computer and control the money supply in the euro area with a so-called" money creation multiplier "..."

It could begin like this, the fairy tale of the money creation multiplier.

The fact that central and commercial banks cannot make gold out of straw, but can create money out of nothing with a few clicks on the keyboard of a computer, should have got around by now and was also the subject of discussion here on Friday.

In this respect, the central banker is absolutely right in the fairy tale when he claims that he can conjure up money.

All of our central bankers, Mario Draghi, are just about to wave the magic wand and generate unimaginable sums of central bank money. In January Draghi announced that he would buy government bonds of up to 60 billion euros per month from March 2015 to September 2016. Nineteen months a 60 billion makes 1 trillion and 140 billion euros.

Where does Draghi get all the money from? As mentioned above, money is the least of its problems. He invents the necessary money simply by crediting the commercial banks from which he buys government bonds the corresponding amount to their central bank accounts.

Jens Weidmann, after all President of the Deutsche Bundesbank, put it in a refreshingly clear speech:

“Central banks create money by lending commercial banks in return for collateral or by buying assets such as bonds. The financial strength of a central bank is in principle unlimited, since a central bank does not have to procure the money that it grants or with which it pays in advance, but can create it from nothing. "

If you think through Weidmann's utterances, Draghi can credit commercial banks with billions, trillions, or quadrillion - whatever he likes. The amount of money Draghi creates depends only on the amount he keyed into his central bank calculator.

But what does Draghi want to achieve with the creation of € 1 trillion in central bank money?

Die ZEIT put it as follows:

“With the program, known in technical jargon as quantitative easing or QE, the central bank buys government bonds from banks and financial companies, thereby pumping a lot of fresh central bank money into the financial cycle. Ideally, this money arrives in the form of loans with companies and consumers and thus helps the economy as a whole and supports the economy. "

What is correct about ZEIT's statement is that a lot of new central bank money is coming into circulation. What is wrong, however, is that this money could reach companies or consumers.

The commercial banks do not pass the central bank money on to the companies, but they need the central bank money in order to generate deposit money for their part. And it is this deposit money that reaches companies and consumers as a loan. When generating deposit money, the commercial banks have to meet the so-called minimum reserve requirement, for which they need the central bank money created by Draghi.

The minimum reserve in the euro area is currently 1 percent, so that commercial banks can theoretically generate 100 trillion euros of deposit money from 1 trillion central bank money.

But will they do that too?

100 trillion euros?

Probably not.

But how much deposit money do commercial banks generate from EUR 1 trillion in central bank money?

Five trillion? Or ten or fifty?

We'll look into it.

This is where the so-called "money creation multiplier" comes into play, which Wikipedia explains as follows:

“The money creation multiplier is a monetary theoretical model that explains the interaction between central banks, commercial banks and non-banks (households and companies) in the development of the money supply. The model assumes a multiplication of money by the commercial banks on the basis of the monetary base issued by the central bank (central bank money) - hence the term multiplier. "

The model of the money creation multiplier aims to establish a connection between the amount of central bank money (so-called money supply M0 - read: "M ZERO") and the amount of money that the commercial banks generate (so-called money supply M3).

The question to be investigated is whether there is such a connection between the central bank money supply M0 and the money supply M3 or whether M3 is developing largely independently of M0.

Fortunately, the ECB has statistics for every imaginable value and of course also for the development of the money supply Mo and M3.

The following table summarizes the money stocks M0 and M3 since 1999 according to the information provided by the ECB and the last column shows the ratio of the giro money stock of commercial banks (= M3) to the amount of central bank money M0.

Year M0 M3 M3 / M0

in € million in € million

1999 460.847 4.664.613 10,12

2000 478.001 4.858.220 10,16

2001 426.215 5.402.134 12,67

2002 480.453 5.765.889 12,00

2003 548.711 6.149.075 11,21

2004 614.084 6.536.824 10,64

2005 692.918 7.084.472 10,22

2006 771.805 7.756.850 10,05

2007 841.899 8.655.100 10,28

2008 1.150.668 9.404.480 8,17

2009 1.052.340 9.353.416 8,89

2010 1.073.068 9.291.999 8,66

2011 1.335.315 9.498.258 7,11

2012 1.630.969 9.780.943 6,00

2013 1.194.434 9.830.593 8,23

2014 1.192.512 10.309.234 8,64

Data source: ECB

The following can be determined:

In 1999, M0 was € 461 billion and M3 was € 4,665 billion. If you want to establish a ratio of M0 and M3, it was 1:10 in 1999. From 1 euro central bank money, 10 euro bank money of the commercial banks was created. If you want to talk about the money creation multiplier, it was 10.

Until 2007, M0 and M3 developed relatively parallel, so that in 2007 M0 was 842 billion euros and M3 was 8,655 billion euros. Between 1999 and 2007 the ratio of M0 and M3 was always between 1:10 and 1:13.

But then came the crisis and the development of the money supply changed dramatically.

While M0 (i.e. the central bank money stock) initially grew strongly from 2007 to 2008, it fell again in 2009, only to grow strongly again in 2011 and 2012, and then to decline again noticeably.

M3 behaved completely differently. M3 grew only marginally between 2008 and 2013.

If the development of M0 and M3 diverges, the relationship between the two money supplies also changes permanently. If the ratio M0 / M3 initially decreased from 1:10 in 2007 to 1: 6 in 2012, it rose again to approx. 1: 9 by 2014.

Now one might think: Well, in the worst case so far in 2012, EUR 1 of central bank money resulted in EUR 6 of deposit money from commercial banks - so the EUR 1 trillion of central bank money that Mario Draghi wants to generate by September 2016 should also be at least EUR 6 trillion in deposit money arise and the money supply in the euro area grows to at least 16 trillion euros.

On superficial examination one might come to this conclusion - in reality, however, the situation is very different:

From 2010 to 2012, the central bank money stock M0 grew from 1,052 billion euros to 1,631 billion euros. The ECB was already flooding the market with huge amounts of central bank money and expanded M0 by 579 billion euros, or 52 percent.

And what did M3 do during this period?

In any case, M3 did not grow by 52 percent, but only by a comparatively ridiculous 5 percent. Strictly speaking, from 9,292 billion euros to 9,781 billion euros and thus by 489 billion euros.

Oops - 579 billion euros in central bank money resulted in just 489 billion euros in deposit money. If you want to derive a so-called "money creation multiplier" from this, it was 0.8 - from 1 euro of central bank money there was just 0.80 euros in deposit money, which was received by the economy or consumers as credit.

A stable money creation multiplier looks somewhat different.

But it gets even worse if you look at the development from 2012 to 2014.

M0 fell from 1,631 billion euros to 1,193 billion euros, a decrease of 27 percent. And what was M3 doing? Did this also decrease? Somehow you would have expected if there were to be something like a money creation multiplier. But - M3 by no means fell - M3 even rose by 5 percent.

What does all this tell us?

There is no fixed relationship between the amount of central bank money and the amount of money that commercial banks generate.

So there is no money creation multiplier.

To go back to the original fairy tale: So the dwarf had mostly lied. He could neither turn straw into gold nor control the money supply in the euro area.

The control of the money supply M3 by changing the central bank money supply is therefore a fairy tale, which, however, is held to be the truth in large parts of the financial economy.