Excess liquidity and the usefulness of the money multiplier

Jan Marc Berk and Jan Willem End

Working Papers from DNB

Abstract: Despite being an identity, the money multiplier (MM) is also a useful summary of the financial intermediation process as it can be interpreted as the rate of substitution between inside and outside money. By modelling the supply and demand for inside and outside money, we provide this rate of money substitution with behavioural underpinnings. Our model illustrates how the creation of large outside money balances by central banks induces behavioural changes, creating an environment characterised by a low MM and low market interest rates. The outcomes of switching regressions for the US and the euro area confirm that such a low regime can be distinguished from a conventional MM regime. The low regime reflects a state in which the functioning of the financial system changes fundamentally due to excess supply of reserves. This so-called excess liquidity trap has adverse economic consequences, is persistent, and cannot be solved by monetary policy alone. We argue that government and supervisory measures taken during the pandemic provide an example of supporting policies that are effective in escaping the excess liquidity trap.

Keywords: monetary policy; interest rates; money multipliers (search for similar items in EconPapers)
JEL-codes: E51 E52 (search for similar items in EconPapers)
Date: 2022-03
New Economics Papers: this item is included in nep-cba, nep-eec and nep-mon
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Journal Article: Excess Liquidity and the Usefulness of the Money Multiplier (2022)
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Persistent link: https://EconPapers.repec.org/RePEc:dnb:dnbwpp:740

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