The monetary base – such a common concept in the literature – plays no role in the determination of money supply (…)”

Borio, Claudio (2019) “On money, debt, trust and central banking,” BIS Working Papers No: 763, Bank for International Settlements, p.7, http://www.bis.org.

This recent paper of Claudio Borio, who currently is the Head of the Monetary and Economic Department of the BIS, is a must read for all students of monetary economics.

The way that monetary policy is conducted by central banks has changed fundamentally since early 1980s.  The central banks started to set the short term interest rate directly and use it as  their main policy instrument. Claudio Borio had recognized the potential implications of this structural change on monetary theory in mid 1990s:

This analysis is something any central banker responsible for implementation would find familiar. But it had not filtered through sufficiently to academia. When I first discovered it the mid 1990s, much to my disappointment I had to throw out of the window everything I had learnt in textbooks and at the university on the topic.”

Ibid, p.7.

Based on the experiences first of the Bank of Japan, and then after the global financial crisis,  of the Federal Reserve, of the Swiss National Bank and of the European Central Bank with either “large scale asset purchases” or “long term refinancing operations,” which increased free bank reserves held at the central bank and thereby the monetary base many times, with a negligible impact on the broad money stock, one cannot agree more with Borio (2019) in concluding:

(…) the money multiplier – the ratio of money to the money base – is not a useful concept.”

Ibid, p.7.

Yet I will argue in my future blog entries that explaining and modelling broad money growth via an alternative theory is possible, and would indeed be useful in macroeconomic policy analysis.