I am preparing lecture notes for my Money and Banking class and wanted to track how the M1 Money Multiplier has changed over time. And I saw this:
You will notice two things. First that the multiplier has fallen steadily since 1984 from nearly 3 to around 1.5. I’ll go into much more detail in a future post. The second thing to notice is that the multiplier has recently plunged below one! That means that for every additional $1 in the monetary base added by the Fed, the money supply is increasing by less than that amount. Is this because banks are fearful of lending? Is it because they are shoring up their balance sheets? Is it because they are anticipating regulatory changes? Something else?
I think the bank are shoring up battered balance sheets, plus the Fed now pays interest on excess reserves, so banks are keeping more reserves (that’s one of the best moves the Fed has made to date, in my opinion). I think those are the main issues. Less desire to lend may be at play, too, but the Fed has done a nice job of steepening the yield curve, so I’m skeptical. And borrowing volumes are coming back, albeit modestly.
Demand deposits are banks are up massively. http://research.stlouisfed.org/fred2/series/WDDSL?cid=25
In addition to excess reserves payments, I would imagine this also reflect investors pulling money out of risky assets (basically, everything except Treasuries right now) and sticking them into FDIC-insured accounts. Especially now that the FDIC limit has been raised.
Has the Fed lost control of the velocity of money? Did they ever have control? Does it even matter?
My guess is that it is due to assets being valued at market prices, and the whole housing bubble thing. Although it would be fun to invent a story about the greedy capitalist bankers conspiring against the common, hardworking man (say, banks colluding to keep interest rates high).
My hypothesis is :
1. Fed has been printing more $ to just shore up lot of these banks..so majority of the money is used to just save a lot of these banks from bankruptcy
2. rest of the banks are fearful about opportunites that are out there, in terms of risk. Last thing they want now is share holders asking them ..” Why did you go lend when you know the market is so risky”