The Determinants of the Money Multiplier in the United Kingdom

By Beenstock, Michael | Journal of Money, Credit & Banking, November 1989 | Go to article overview

The Determinants of the Money Multiplier in the United Kingdom


Beenstock, Michael, Journal of Money, Credit & Banking


The Determinants of the Money Multiplier in the United Kingdom

THE MONEY MULTIPLIER DEFINES THE RELATIONSHIP between the money stock and the monetary base ([M.sub.o]). Monetary growth may be analyzed in terms of the determinants of the money multiplier along the lines described, for example, by Black (1975) in conjunction with an account of how the monetary base is determined. To our knowledge there has been no previous econometric attempt to explain the determinants of the money multiplier in the United Kingdom.

This multiplier approach to the determination of the money supply may be contrasted with the "counterparts approach" of trying to explain the individual counterparts of the change in the money supply including public sector borrowing, bank lending, sales of public sector debt to the nonbank private sector, and net capital flows from overseas [see e.g., Spencer and Mowl (1978) and Melitz and Sterdyniak (1979)]. However, the two approaches, in principle, merely involve different points of departure rather than differences in substance.

Our preoccupation in the present paper is with the determinants of the multiplier rather than the determinants of the monetary base. Our analysis therefore only provides an account of the determination of the money stock if it is assumed that [M.sub.o] is exogenous and controlled by the authorities.

In the next section of this paper we set the scene with a brief resume of British monetary policy since 1950. In section 2 we present data on the money multiplier and analyze some of its determinants. Of particular significance is the structural break that has occurred in the multiplier since the 1970s. Sections 3, 4, and 5 are concerned with the econometric estimation of the multiplier in terms of the currency ratio, the time deposit ratio, and the reserve ratio, respectively.

These results are brought together in section 6 in which we seek to determine whether our model provides a good empirical account of the behavior of the money multiplier since 1950 using static as well as dynamic simulation techniques. The success of this exercise may be of interest to those attempting to model the monetary sectors of other countries, in addition to students of the British monetary scene. In this section we also carry out counterfactual simulations to explore the effects of the progressive elimination of the cash ratio requirement as well as the payment of interest on sight deposits since 1975. In addition, we calculate the model's dynamic multipliers, which indicate how the money multiplier evolves over time to shocks in output and interest rates.

Conclusions are presented in section 7.

1. THE INSTITUTIONAL AND POLICY SETTING

Monetary policy is at the best of times hazardous to interpret. It is difficult to be sure whether interest rates are the effective instrument of policy, or whether monetary aggregates assume this role at any point in time. And even if the former is true there may be a hidden monetary target that motivates interest rates. Or if there is an explicit monetary target it does not necessarily follow that interest rates are entirely endogenous.

Although this ambiguity applies in Britain as elsewhere, there have nevertheless been several broadly distinct phases in the operation of monetary policy over our observation period (1950-1984). Until approximately the mid-1970s monetary aggregates carried a very low weight both directly as an operating instrument of policy and indirectly as an intermediate target. During this period interest rates were on the whole the main instrument of monetary policy while monetary aggregates were endogenously determined. Indeed, this perception of monetary policy was reflected in the econometric efforts of, for example, Goodhart and Crockett (1970) to estimate money demand functions in which interest rates were assumed to be exogenous and the quantity of money endogenously demand-determined.

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