The ratio of the broad measure of the money supply to the monetary base has fallen dramatically in many nations during the financial crisis which indicates that the money multiplier has fallen.
Answer: False
The answer is False.
While mainstream economists would argue the answer is true the justification for the false answer is based on a refutation of the theoretical basis of the "money multiplier". This refutation requires a firm understanding of how the banking system works.
It has been demonstrated beyond doubt that there is no unique relationship of the sort characterised by the money multiplier model in mainstream economics textbooks between the monetary base (currency plus bank reserves) and the broad monetary aggregates (such as M2 in the US, M3 in the Eurozone and M4 in the UK).
You will note that in MMT there is very little spoken about the money supply. In an endogenous money world there is very little meaning in the aggregate.
The mainstream theory of money and monetary policy asserts that the money supply (volume) is determined exogenously by the central bank. That is, they have the capacity to set this volume independent of the market. The monetarist portfolio approach claims that the money supply will reflect the central bank injection of high-powered (base) money and the preferences of private agents to hold that money. This is the so-called money multiplier.
So the central bank is alleged to exploit this multiplier (based on private portfolio preferences for cash and the reserve ratio of banks) and manipulate its control over base money to control the money supply.
Note that the mainstream concept of the multiplier allows for these preferences to change (although an explanation for such changes is outside of the theory - which means mainstream economists would not be able to explain or anticipate them). In that sense, the empirical movements that we observe could still be consistent with the money multiplier concept although but then we would conclude the characterisation has little practical value - such is the instability of the ratio between broad money and the base.
But there are even more compelling reasons to reject the concept of the money multiplier which are also capable of incorporating the observed empirical movements.
The mainstream model is predicated on the erroneous assertion that the the central bank could can control the stock of money. But in a credit money system, this ability to control the stock of "money" is undermined by the demand for credit.
The theory of endogenous money is central to the horizontal analysis in MMT. When we talk about endogenous money we are referring to the outcomes that are arrived at after market participants respond to their own market prospects and central bank policy settings and make decisions about the liquid assets they will hold (deposits) and new liquid assets they will seek (loans).
The essential idea is that the "money supply" in an "entrepreneurial economy" is demand-determined - as the demand for credit expands so does the money supply. As credit is repaid the money supply shrinks. These flows are going on all the time and the stock measure we choose to call the money supply, say M3 is just an arbitrary reflection of the credit circuit.
So the supply of money is determined endogenously by the level of GDP, which means it is a dynamic (rather than a static) concept.
Central banks clearly do not determine the volume of deposits held each day. These arise from decisions by commercial banks to make loans.
The central bank can determine the price of "money" by setting the interest rate on bank reserves. Further expanding the monetary base (bank reserves) as we have argued in recent blogs - Building bank reserves will not expand credit and Building bank reserves is not inflationary - does not lead to an expansion of credit.
Banks prefer to hold some desired reserves with the central bank to ensure that all the claims on them each day are able to be met. That is, to facilitate the integrity and stability of the payments system.
But ultimately the banks know that if they are short of reserves on any particular day they can call on the central bank to supply the additional reserves to keep the payments system liquid and prevent financial instability (where cheques bounce and panic sets in).
Should the central bank refuse to provide those reserves (because it wants to "control" the money base), the banks would then have to maintain much larger buffers which would make the overnight money market (the interbank market) very liquid indeed.
The impact of that "excess liquidity" would be that banks would be trying to get a competitive return on their excess reserves by lending to each other and effectively the excess would drive the overnight interest rate down. As noted in the quote - "short-term interest rates ... would then be determined by the market rather than monetary policy makers".
That is, the central bank would lose control of its monetary policy tool - the setting of short-term interest rates.
So while the monetary base responds to movements in the broader aggregate because the central bank will always provide reserves to banks on demand, the reverse is not the case.
Movements in the broader aggregate are endogenously driven by the state of the economy - in particular, the demand for credit by households and firms.
So a declining ratio of some money stock measure to bank reserves is best explained by the fact that credit creation is being constrained by some factor - such as a recession.
You might like to read these blogs for further information: