Negative money multiplier
My old friend Peter Stella and IMF colleague M. Singh has a new VOX post based on their IMF WP Money and Collateral. They argue that we should not fear inflation due to excess reserves, since the money multiplier is not working anyway. The shadow banking system is now creating much of the credit, but also need support in the crisis from central bank liquidity support. But since the shadow banking system is based on repo financing in government paper, central banks should support the system by doing QE in other undervalued papers, like asset based securities.
Whereas I liked their IMF WP, this post needs some discussing. First of all, the money multiplier is long dead anyway. For a good discussion of whether excess reserves will create inflation, this see blog post by McAndrews of NY Fed. Second, they correctly note the huge size of financial market assets relative to very little reserves, but do no discuss further the advisability of operating a financial system of private credit with so little official backing.
As I have noted earlier in my Levy WP “Shadow banking and the limits to central bank liquidity support” there is probably a limit to how far central banks should accommodate the endogenous expansion of shadow credit. Unless credit creation is somehow constrained, central banks cannot simply go on to support private liquidity markets with endlessly new QEs.
If you are interested in the FT’s view on the issue, Isabelle Kaminska of Alphaville devotes two long posts to their paper.