There has been a debate raging in the blogosphere as to whether there really is a credit crunch. On one side of the debate is Alex Tabarrok and these authors who argue that while there is some stress in credit markets there is no systemic credit crisis such as the one in 1990-1991. Taking the opposive view is Mark Thoma, Tyler Cowen, John Kwak, Free Exchange and, well, almost everybody else.
When thinking about the credit crisis question, I think it is useful to look at the money multiplier for the monetary base. The monetary base is a measure of money that includes currency in circulation and bank reserves. It is also a measure of money that the Fed controls and uses to alter liquidity in the banking system. In normal times, the Fed can increase the monetary base by injecting reserves into the banking system. Banks, in turn, lend out a portion of these reserves to borrowers who then spend the funds. The parties that sold the goods or services to the borrower then takes the funds earned and deposits them in their banks. These new deposits becomes reserves of which a portion are lent out again. This cycle continues until there are no more excess reserves to lend out. The banking system, then, can turn small amount of monetary base into a much larger amount of money. How big the total amount of money becomes relative to the initial injection of monetary base is called the money multiplier.
These, however, are not normal times. Banks' balance sheets are hemorrhaging and the economy is in a recession. Banks are not eager to make loans in this environment and are more likely to sit on the new reserves coming from the Fed. This development means less credit and if pronounced enough a credit crunch. 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. (Click on the figure to enlarge.)
This figure shows the money multiplier peaked the week of 6/4/08 and begin a sharp descent in late August. Compared to the credit crisis of 1990-1991, Y2K, and 911, this drop is huge. This striking drop is mirrored in the figure below which shows total reserves in the banking system:
These figures indicate banks are sitting on their reserves, and lately there has been a lot of reserve creation by the Fed. 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.
When thinking about the credit crisis question, I think it is useful to look at the money multiplier for the monetary base. The monetary base is a measure of money that includes currency in circulation and bank reserves. It is also a measure of money that the Fed controls and uses to alter liquidity in the banking system. In normal times, the Fed can increase the monetary base by injecting reserves into the banking system. Banks, in turn, lend out a portion of these reserves to borrowers who then spend the funds. The parties that sold the goods or services to the borrower then takes the funds earned and deposits them in their banks. These new deposits becomes reserves of which a portion are lent out again. This cycle continues until there are no more excess reserves to lend out. The banking system, then, can turn small amount of monetary base into a much larger amount of money. How big the total amount of money becomes relative to the initial injection of monetary base is called the money multiplier.
These, however, are not normal times. Banks' balance sheets are hemorrhaging and the economy is in a recession. Banks are not eager to make loans in this environment and are more likely to sit on the new reserves coming from the Fed. This development means less credit and if pronounced enough a credit crunch. 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. (Click on the figure to enlarge.)
This figure shows the money multiplier peaked the week of 6/4/08 and begin a sharp descent in late August. Compared to the credit crisis of 1990-1991, Y2K, and 911, this drop is huge. This striking drop is mirrored in the figure below which shows total reserves in the banking system:
These figures indicate banks are sitting on their reserves, and lately there has been a lot of reserve creation by the Fed. 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.
