Some Credit Crunch Realities

The best rebuttal I've seen to the case that the credit crunch isn't all it's cracked up to be comes from David Beckworth. He looks at the money multiplier for the monetary base. The idea behind the multiplier is that the Fed increases the base by lending money to banks. These banks keep a fraction of the money in reserves, as determined by the Fed, and lend out the rest to others. The borrowers then spend the money which eventually winds up being deposited at other banks, where the process begins again until there is no money left to lend out. The amount of money created in the entire economy because of the intial injection from the Fed is multiplier.

But if there is a credit crunch, then even as the monetary base expands because of the Fed, the money supply does not because banks aren't lending. I'll give it over to Beckworth from here:

One implication is that if, in fact, there is a credit crunch then the money multiplier should be sharply falling. Thus, it makes sense to look at the money multiplier. The figure below provides the money multiplier using MZM as the broad measure of money and the St. Louis Fed's monetary base measure. (See here for why MZM is used over M1 or M2.) The data are on a bi-weekly basis and go through the week of 10/8/08.

These figures may not settle the debate, but they do suggest that we are closer to a systemic credit crunch than to a minor credit market hiccup.

Comments

[Kinja Rules:]

You don't bring a conclusion. By the chart it looks as if the the multiplier did fall sharply. I understand your pt about the lending not in fact happening. You brought no conclusion.

2008 Oct 30 05:53 AM

[Moon Kil Woong:]

LOL it looks here like credit got way too lax and now it regressed only back to lax but not ridiculously so. Anyone wanting credit to go back to the way it was is basically asking everyone to remain blind and irresponsible (ergo the Fed and Treasury seem to want this badly). That's why nothing will improve under this retarded administration that thinks every economic problem can be solved by having us buy more and spend.

2008 Oct 30 06:04 AM

[derryl:]

When there is uncertainty and fear for the future people feel like hunkering down and consolidating their position by paying down debt. In this psychological environment it doesn't really matter how much money banks have "available" to lend, because actual people are not coming in asking for new loans. Instead they are paying down existing loans.

So adding to the base money supply (i.e. cash available for banks to hold as reserves against their customers' cash withdrawals of their deposit balances) will have little if any effect.

Just as borrowers are not availing themselves of new borrowing potential, banks do not need to avail themselves of new Fed base money supplies. In fact, as debts are paid down and private/commercial bank assets/deposits decline, banks will need less cash, not more.

This is where Keynes comes in. If people are widely deflating the money supply by repaying loans, and this begins to pinch real economic activity and money flows, government can intervene with infrastructure projects and other direct spending to raise people's incomes. This puts new non-debt money into people's hands and should stimulate buying. Of course if those people just use their incomes to pay down their debt even more this kind of stimulus will still not bring much of a multiplier to the economy. I think Bush's next round of stimulus checks will get pretty much sucked up by debt paydowns.

Ironically, adding money to the system in this way in this kind of "hunkering down" financial psychology environment actually serves to decrease debt/deposits/money supply rather than increase it.

So it's still a free market. It is the borrowing/spending actions of millions of Americans, not the actions of a few Fed and Treasury officials trying to apply levers, that determines what actually happens in the commercial financial system and the economy.

2008 Oct 30 10:55 AM