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Bond MarketMoney Multiplier Mudslinging

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


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