2.3 Multiplier model. Credit creation is led by the banks rather than the central bank

Both NCT and MMT consider the textbook multiplier model – called credit or money or deposit multiplier – to be misleading.[1] The multiplier model was developed by Philipps in 1920.[2] It assumes that a central bank controls the volumes of banks' credit and deposit creation by requiring a minimum reserve to be held on every bank deposit. In the euro area, the minimum reserve rate is at present 1 euro on each 100 euros of liable deposits. In the United States, the obligatory reserve requirement is 10% (with exemptions and vault cash allowable). The minimum reserves on central-bank accounts /22/ are now interest-bearing, i.e. the costs of having to hold such reserves are mercifully low. Minimum reserves are nevertheless non-available under any circumstances. They are not a liquidity safety buffer, as is often assumed, but lie idle and are meant to be an instrument for restricting banks' credit and deposit creation.

In some textbooks the multiplier model starts with a given amount of existing bank deposits, wherever these might have come from. Credit extension is then described as a recurrent process of lending out that amount of deposits in the sense of a recurrent secondary credit minus the minimum reserve required. As explained above, this is ill-conceived from the outset. Commercial banks always make out primary credit. Only nonbanks and investment-'banking' departments deal in secondary credit. Commercial banks cannot on-lend customer deposits. Credit and deposit creation is an ongoing process of creation 'ex nihilo' and extinction on repay. Banks create any credit at discretion, with and without minimum reserve, as long as they have or can obtain enough excess reserves and cash for daily settlement of payments – which, in the last instance, is to say as long as the central bank provides a sufficient supply of reserves on demand.

More appropriate variants of the model assume there is a given amount of central-bank money M0, i.e. reserves and notes. On any credit and deposit which the banks extend they have to reserve a fractional amount, the minimum reserve, as set by the reserve rate of 1, 2 or 10 per cent. The amount of extendable credit and deposits CrôDp then is a corresponding multiple of M0, with the maximum resulting as the reciprocal value of the required minimum reserve: Maximum CrôDp = M0 (1 – minimum reserve). The banking sector, though, cannot fully exploit the maximum, since it needs to have some excess reserves available for final settlement of payments. In practice, excess reserves represent just small amounts.

The multiplier model in this or a similar variant is certainly consistent. And yet, as so often in economics, the model misses one or another important aspect of reality. The multiplier model could be real, if the central bank kept M0 constant. But in fact it does not. Today, central banks always comply with the banks' demand for reserves by reacting to the actions of the banking /23/ sector and refinancing to a fractional degree what banks have decided to credit and purchase.[3]

'In the real world', as Mosler states, 'banks make loans independent of reserve positions, then during the next accounting period borrow any needed reserves. The imperatives of the accounting system require the Fed to lend the banks whatever they need. ... A central bank can only be the follower, not the leader when it adjusts reserve balances in the banking system'.[4]

In actual fact, banks' creation of credit and deposits is the initial and primary proviso. Deposits contribute by far the major part of the entire money supply. Moreover, the banks' proactive credit creation in effect determines the entire money supply, literally 100% of it, because coin and notes are not spent into circulation at source, but are exchanged out of and back into money credited on account. Central-bank reserves are not created pro­active­ly either, but are reactively credited on bank demand – refinancing a mere fraction of what banks have decided to put into circulation.

In order to uphold 100 euros in demand deposits, including newly made out credit and purchases, the euro banking sector in the years up to the crisis since 2007/08 on average just needed about 3–4 per cent in central-bank money, of which 1.5 per cent were cash for the AMTs, 0.1–0.5 per cent excess reserves for final settlement of payments, and 2 per cent idle obligatory minimum reserve.[5] In 2012 the ratio of cash and reserves to demand deposits was at above 12 per cent, due to a flood of interest-bearing reserves from quantitative easing. Sooner or later this will reduce again.

All central banks today avoid leaving 'their' banks with a shortage of reserves. There can of course be different ways in which central banks proceed. For example, in its time, the German Bundesbank practiced partial allotment at a variable rate besides full allotment at a fixed rate. The first method supplies slightly less than the banks had declared they needed, the reserves then going to the bidders that offer the highest interest. The latter method fulfils any demand from who is prepared to buy at the set interest rate. For several years now the ECB has routinely offered full allotment at very low interest (at about 0–1% since the start of the crisis).

/24/ Constraints on bank credit creation certainly exist, e.g. preparedness of nonbanks and banks alike to go into debt. Other factors that can have a certain restrictive effect are equity requirements (e.g. leverage ratio) and quality standards of discountable collateral. Nevertheless, the banking sector will basically always be able to generate enough equity and quality collateral by itself. This is just a matter of time. The 'masters of the universe' create theirs perhaps not in one week, but certainly in a couple of months or a few years. Those restrictions are effective within the period of time necessitated to reach required ratios upon introduction, but of little effect thereafter. The most important restriction is that all banks expand their balance sheet roughly in step so that outflows and inflows among banks are just about offsetting each other. Otherwise those banks that were individually extending too much credit too quickly would run a liquidity risk – possibly even a solvency risk – when, just as to obtain liquidity, they would have to sell too many assets or take up too much debt.


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[1] Goodhart 1984, Ryan-Collins/Greenham/Werner/Jackson 2012 18–25, Huber 2013 42–47, Jackson/Dyson 2013 pp75–80, Wray 2012 80, 112, Mosler 1995 5–6.

[2] Philipps 1920.

[3] Wray 2012 124, 204, Huber 2013 pp48.

[4] Mosler 1995 5.

[5] Deutsche Bundesbank, Monthly Bulletins, tables IV.3 and V.3.