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Source link: http://archive.mises.org/9103/evidence-that-the-fed-caused-the-housing-boom/

Evidence that the Fed Caused the Housing Boom

December 15, 2008 by

During the boom years, Greenspan and his fans wanted to take credit for his “merciful” low rates which allowed the United States to avoid a painful recession, but now Greenspan and his defenders want to claim that he was an innocent bystander in the face of Asian thrift and shortsighted bankers. Still, the fact is undeniable: Greenspan allowed the monetary base to grow quite rapidly precisely when the housing boom shifted into high gear, and precisely when interest rates collapsed. FULL ARTICLE


fundamentalist December 15, 2008 at 8:58 am

Excellent analysis!

Critics like to focus on very narrow aspects of the issue rather than step back and look at the broad picture. As Murphy points out, DeLong deliberately ignores the effects of fractional banking, even though he is well aware of it. Focusing just on interest rates is another flaw in the Greenspan cult. Mortgage rates need not have been very low in order to spur investment in real estate because mortgage companies can entice borrowers with other means, such as reducing points and closing costs, reducing down payments to zero, doing ARMS and interest only loans, and ignoring income requirements. Why would mortgage companies engage in such risky behavior? Because they thought the price of housing would rise forever. The Fed’s low initial rates started housing prices rising and people began to expect that they would always rise no matter what. Mortgage companies jumped in to get their share of deals by lowering credit standards, which fed the fire and caused housing prices to rise further. In addition, mortgage generators were able to sell the loans for high fees to the secondary market and unload the risk.

Hayek has a good general description of the process in “Monetary Theory and the Trade Cycle.” The bubble starts because banks just do what they naturally do: they lend money and compete for profits. If every other bank is lowering credit standards and making huge profits, the pressure for others to join in is great.

I would like to ask the Greenspan cult where the money to buy all of those houses came from if not from the Feds? After all, with a fixed money supply, people would have to dramatically reduce their purchases of other things in order to buy that many houses. Yet, Americans didn’t reduce their purchases of anything, even while gasoline prices were climbing, too. Some were quick to respond that the money came from China, but where did China get all of those dollars? They got them from Americans buying Chinese goods. So the China defense leads back to American purchasing power. Americans were able to buy huge numbers of houses, oceans of oil at rising prices and most of China’s output, but the money supply didn’t grow very much. How can that be?

Grant December 15, 2008 at 9:30 am

I found the article less convincing that fundamentalist.

1) How often is the money multiplier on injected funds (i.e., at the margin) really 10, or anywhere near 10? I’m not sure if this (http://research.stlouisfed.org/fred2/series/MULT) s the correct data-series, but this isn’t reassuring. That said, we all know the housing sector was very over-leveraged, so I’d expect the multiplier to be higher there.

2) I don’t believe ABCT has any explanation for why a boom would occur in a specific sector, or why a ponzi-scheme would develop out of house prices.

3) Blaming so much on the Fed seems unrealistic given the obvious corporate governance failure of many firms.

I won’t deny ABCT has some explainable power, but it really seems like the Austrians’ hammer, while everything looks like a nail…

Mark Knutson December 15, 2008 at 10:25 am

There were many factors that lead to the boom, not the least of which was the natural human tendency to take risks and increase investment in assets with rising values.

Another factor was the GSEs purchasing mortgages which were inadequately collateralized.

Corporate mismanagement in the financial sector was significant, and the proper cure would be to allow such firms to fail. The bailout creates moral hazard which rewards mismanagement and penalizes prudent management.

Naturally, a 100% reserve requirement would protect bank deposits from the vagaries of other bank speculative activities. As it stands, the FDIC transfers taxpayer money to banks whenever their other investment activities make the bank insolvent, or insufficiency solvent to withstand a run.

Alex December 15, 2008 at 10:29 am

It’s so wierd sometimes. We have a prediction of a great depression early in the 19th century – by Austrian economists. It happens. No one listens (perhaps the Grant’s of this world?)

Then we have several bubbles, predicted by Austrians again, when they see the actions that the Fed is doing. Again, people either ignore it, or nitpick it to do death (the Grant’s of this world).

After all, an explanation of how this happened couldn’t be so simple, could it? I mean, there has to be something more, right?

Reminds me of the debacle of some posters on here critizing rudimentary economic theory in regards to minimum wage laws. Why, you Austrians are just using hammers, and everything looks like nails! (For the record, Grant, Bob didn’t say this was the only reason why the housing bubble happened; just that it was probably the most important one).

And so again. We will probably end up with another bubble some years from now, predicted (again) by Austrians. And still other people will make comments like ‘well yeah but I don’t know’ or ‘well yeah but his doesn’t exactly explain absolutely everything’ or ‘well you guys are just using hammers, and everything is a buncha nails now’ blah blah.

I wonder if some people who fail art class do so because they can’t connect two lines. Herm. Seems to be the same with economics.

DD December 15, 2008 at 11:01 am


I think one has to understand the ramifications of the Austrian business cycle theory, in order to understand mainstream’s denial and unwillingness to accept it. I don’t think the theory or the evidence is the problem. It is the conclusions that one must draw once he accepts the Austrian analysis. The conclusions are quite obvious: Government intervention in any form or any amount is not workable as far as monetary policy and banking! I don’t see how mainstream which is so dependent on Government and banking employment and funds can ever reach such a decisive conclusion.

fundamentalist December 15, 2008 at 11:04 am

Alex: “After all, an explanation of how this happened couldn’t be so simple, could it? I mean, there has to be something more, right?”

Good points! It reminds me of the hedgehog and fox analogy. Isaiah Berlin lumped “intellectuals and artists into two categories: the fox, who is clever, creative, committed to many goals; and the hedgehog, a creature by a single, unwavering conviction.” The left tends to be foxes. They’re “pragmatic” and know a lot of clever things. But pragmatism is nothing but a euphemism for short-term thinking, and the many clever things they know are often wrong and a tangled mess of contradictions. Foxes are incapable of taking the long term view or of organizing their many clever ideas into a unified theory. As a result, they distrust all theory.

Austrians tend to be hedgehogs. But what foxes see as “unwavering conviction” is actually careful thought an analysis that leads to a long-term view of things and the synthesis of theory without contradictions. Hedgehogs are leery of pragmatic solutions because they know that today’s mess was caused by yesterday’s “pragmatic” answers.

Mark Knutson December 15, 2008 at 11:27 am

I just read mises saying that to those in charge, economists are an irritant because they say the market is more powerful than the rulers. Since rulers today have ‘court’ economists who say what the rulers want to hear, the quote can be amended to ‘austrian economists are an irritant to the rulers’.

The predictive accuracy of austrian economics does not win many people over due to its bitter medicine of requiring short term sacrifice for long-term benefit, and reduction in government handouts.

The other problem is that in a country where many people can’t distinguish what sarah palin actually said from what an actress said on a skit on saturday night live, the intellectual burden of studying economics is too high.

Grant December 15, 2008 at 11:52 am


I’m quite familiar with ABCT, thanks. Austrians are always predicting bubbles – probably because governments are always inflating. If correlation was causation, we’d all be studying econometrics.

I’m not denying the Fed was a major cause of the bubble, but I don’t think its as major of a cause as Mises.org often argues. There are things ABCT does not explain, and just because some bubbles can be caused by credit expansion doesn’t mean they all are. Austrians can derive laws of economics, but it takes empirical work to connect those laws to actual events. I don’t think Dr. Murphy’s post here is very good empirical work because I’m willing to bet the multiplier on funds injected into real estate wasn’t anywhere near 10. The Fed claims the overall money multiplier during that time was less than 2.

But I could be wrong. I’d like someone to show me where and why instead of offering aimless criticism.

fundamentalist December 15, 2008 at 12:23 pm

Grant: “I don’t believe ABCT has any explanation for why a boom would occur in a specific sector, or why a ponzi-scheme would develop out of house prices.”

The ABCT says that bubbles will occur in the sectors that receive the new money first. That’s all. It’s not hard to see that the newly minted money went primarily into the housing market.

Grant: “Blaming so much on the Fed seems unrealistic given the obvious corporate governance failure of many firms.”

The ABCT says that credit expansion gets the boom rolling. Psychological factors then kick in as people experience euphoria and many expect it to last forever. The theory doesn’t say that credit expansion alone and nothing else contributes to the boom, only that credit expansion is necessary and sufficient to initiate the boom and the boom could not happen or continue without credit expansion. Many things contributed to the boom after it got started, but those things would not have happened without credit expansion starting the boom.

Grant: “..it really seems like the Austrians’ hammer, while everything looks like a nail…”

Or maybe you really don’t understand the ABCT as well as you think.

Grant: “Austrians are always predicting bubbles – probably because governments are always inflating. If correlation was causation, we’d all be studying econometrics.”

Austrians don’t use correlation to predict bubbles. They use sound reasoning. And no Austrian is predicting a bubble right now.

Grant: “I’m not denying the Fed was a major cause of the bubble, but I don’t think its as major of a cause as Mises.org often argues.”

Even mainstream econ grudgingly admits that even if credit expansion doesn’t cause the bubble, it is absolutely necessary for the bubble to grow at all.

Grant: “I’m willing to bet the multiplier on funds injected into real estate wasn’t anywhere near 10. The Fed claims the overall money multiplier during that time was less than 2.”

Several different kinds of multipliers exist in economics and I’ll bet you refer to two different ones. Usually, what mainstream econ refers to as a multiplier is the Keynesian multiplier where state spending increases the GDP. It’s closely related to velocity. A lot of empirical work says the actual Keynesian multiplier is just 1. In other words, there is no multiplier. Murphy doesn’t refer to that multiplier. He refers to the fact that when a bank takes in a dollar it can loan out 90 cents if the reserve requirement is 10%. That causes a dollar in deposits to translate into just less than $10 in the money supply. Hayek’s “Monetary Theory and the Trade Cycle” is a good short explanation of how that works.

Mark Knutson December 15, 2008 at 12:51 pm

As I have said, the current financial mess is the result of all organs of government working on concert to enrich cronies, pander for votes, and advance collectivist ideology. Aided and abetted by a keynsian-educated public who doesn’t study history and thereby only learns about bubbles first-hand. (Since we had the tech bubble less than a decade ago, maybe learning is too strong a word.)

For the purpose of setting sound financial policy, its only necessary to show that, to the extent that it influences the money supply and availability of credit, the fed plays a key role in creating the problem. Sound financial policy being to eliminate or sharply curtail the fed, and set 100% bank deposit requirements.

Eric December 15, 2008 at 1:27 pm

Fundamentalist has it right. The bubbles appear wherever the new money goes first.

And the new money generally goes to a place that is a “fad” at the time of the expansion. So, of the last 2 bubbles, the first fad was the stock market and the dot com’s in particular. The recent fad was real estate.

As Fundamentalist said, the money for all those loans had to come from somewhere, and I don’t recall any “credit crunch” in areas that were not real estate releated.

So if nobody was crying about lack of funds for non-real estate loans, this would seem to me to indicate that the money supply had to be increased, as the real estate bubble was growing. If nothing else, larger sums were being borrowed to pay for the higher prices of houses.

There is one other possibility, however, and that is that there had been hoarding of these funds (i.e. not invested, but say people keeping FED notes under the bed) prior to the bubble and then released during the bubble formation. I’m not sure how to determine if this was the case – and how much of it occurred, if any.

Econophile December 15, 2008 at 2:06 pm

I had been struggling a bit to fit the monetary data into the ABCT and thank you, Bob Murphy for doing a brilliant job. In a world where empirical analysis is the norm, it’s nice to discuss complex theory, but perhaps more of this kind of analysis will help lead people to the theory.

Grant December 15, 2008 at 2:12 pm


I don’t think ABCT shows that a bubble cannot occur without credit expansion. I think its pretty obvious that a cluster of malinvestments can occur without the former, though they seem to be relatively rare and smaller in size and scope. Plain old human fallibility is always going to strike eventually.

I think you’re mistaken on how fractional reserve money multipliers work. Wikipedia has a good page on it. Its really just straight math. With 10% reserve requirements, the multiplier can only approach 10 as the number of loans in the chain approaches infinity. For instance, say $100 is deposited:

Bank 1 can loan out $90 to bank 2, keeping $10 as reserves.
Bank 2 can loan out $81 to bank 3, keeping $9 as reserves.
Bank 3 can loan out $72.9, keeping $8.1 as reserves.

If the process stops there, you get $100 being turned into $343.90, so the multiplier is 3.4. The process has to stretch on to infinity for the multiplier to hit 10, so its always less than 10 and greater than 1.

That said, I’m not sure I posted the correct data series from the Fed. I’m open to the possibility that the money multiplier of the reserves created by Greenspan were much higher than the series indicates.

You mention that bubbles appear where the new money goes first. No argument here! My question is, WHY did the new money go into housing, or any one specific sector? ABCT, as I’ve read it mostly from Garrison, cannot say. In the late 90s, why did it go into dot-com stocks?

As I’ve mentioned before, I believe the answer is: innovation that many established investors didn’t fully understand. Their lack of understanding of the new-fangled Internets and financial instruments meant they were easier prey for a bubble. Some Austrians have pointed out the game-theoretic reasons that newly-created money is going to be lent out, due to the incentives banks face. So I believe its going to find its way into the parts of the economy where investors are most likely to make mistakes. In short, I believe some investors do have rational expectations of the future, long-term interest rates, mortgage rates, and all that. ABCT blind-sides the ones that don’t (and there are always ones that don’t), because only the ones who don’t take advantage of the new credit.

Grant December 15, 2008 at 2:36 pm

It looks like Anthony Evans and Toby Baxendale may have already delved into what I’m trying to discuss:

They’re arguing credit expansion causes adverse selection, because it enables people who previously couldn’t afford capital, to suddenly afford it.

Now I just need to find a link to an ungated version…

Wren December 15, 2008 at 2:50 pm

Quick question: weren’t reserve requirements more lax during the boom, thus allowing the money supply to inflate even more?

In this article Bob Murphy states that it is possible to have a tenfold increase of the money supply with a 10% reserve requirement. That’s theoritically true, but I was listening to Joe Salerno’s lecture on casual-realist approach to economics, and I think he mentions that empirically and in real life, the multiplier doesn’t quite get that high. At most there is around a fourfold increase, not the possible tenfold. Please correct if I’m wrong. However, if I’m not wrong, then this conclusion by Bob Murphy is:

“In particular, if the required reserve ratio is 10 percent, then a given injection of new reserves (through Fed purchases of securities) allows up to a tenfold increase in the quantity of new money. So with that rule of thumb, a $200 billion injection would be expected to have an impact of … $2 trillion.”

I think that is far too simplistic and disingenuous. Just because there was an allowance of the money supply to multiply tenfold, it does not follow that it happened in actuality.

But if there was some reserve requirement deregulation, the multiplication of $200 billion to $2 trillion seems to me more plausible.

fundamentalist December 15, 2008 at 2:57 pm

Grant: “I don’t think ABCT shows that a bubble cannot occur without credit expansion. I think its pretty obvious that a cluster of malinvestments can occur without the former, though they seem to be relatively rare and smaller in size and scope.”

Well, that’s what it claims to show. You may not agree. While random clusters of malinvestment do occur, by definition they wouldn’t occur on the regular basis that depressions do nor would they have the magnitude. The regular occurrence of error in the capital producing industries is what the ABCT aims to explain.

Grant: “The process has to stretch on to infinity for the multiplier to hit 10, so its always less than 10 and greater than 1.”

No. It only has to go to ten loans to reach the max increase in money.

Grant: “I’m open to the possibility that the money multiplier of the reserves created by Greenspan were much higher than the series indicates.”
I think you’ll find that they are two different multipliers referring to different things.

Grant: “WHY did the new money go into housing, or any one specific sector?”

You’re right. The ABCT doesn’t say and can’t say if it wants to be a general theory. You’re asking for an explanation of how this specific bubble happened, which is different from creating a general theory about business cycles. Each bubble is going to be different in its particulars, but still fits the ABCT. Eric has a good explanation as to why the new money went into housing.

Grant: “ABCT blind-sides the ones that don’t (and there are always ones that don’t), because only the ones who don’t take advantage of the new credit.”

I agree. We have the institution of fractional banking that expands the money supply through credit creation very rapidly, yet the bankers, politicians, media and most economists say nothing bad will happen from this. So the public goes along, thinking prosperity will last forever. Loose money loosens morals and encourages risky behavior.

Grant December 15, 2008 at 2:59 pm

Wren, see my above post and wikipedia link. I think you’re correct.

Arnold Kling stresses that capital requirements for MBSs were different, and gave them an advantage over, traditional ways to hold mortgages. I’m not sure if this translates into a high money multiplier or not, but I would think that it would. How high? I have no idea…

Wren December 15, 2008 at 3:02 pm

Grant, does the ABCT not providing explanation as to why booms occur in a certain sector, discredit the theory for you? To me, that fact is a secondary issue.

Grant December 15, 2008 at 3:19 pm


I really don’t think any Austrians claim that ABCT is the only source of business cycles? I’m not sure I’ve heard that rigorously defended anywhere? Logically speak, proving that A causes B does not disprove a theory that states X, Y or Z can also cause B.

No. It only has to go to ten loans to reach the max increase in money.

I think you’re incorrect here. I can’t draw out formulas here, but look at the following wikipedia page:

The theoretical maximum multiplier of 10 is an asymptote. I should also note that not all banks operate at the limit of the reserve requirement; 10% is the minimum.

wren, no it doesn’t discredit the theory to me. It might lead me to believe other causes are at work besides credit expansion, though I’d really like to read that QJAE paper when Mises.org releases the latest volume.

Fred December 15, 2008 at 3:32 pm

Something of an aside but a contributor to the discussion is the next shoe to fall:


The bloomberg article discusses a $3T bailout for homeowners, via fixed 4.5% 30 yr notes, which looks like it would effectively socialize the entire mortgage industry (more so than it currently is if that’s possible).

I’m curious how it would impact some of the conclusions of this article.


fundamentalist December 15, 2008 at 3:44 pm

Grant: “The theoretical maximum multiplier of 10 is an asymptote. I should also note that not all banks operate at the limit of the reserve requirement; 10% is the minimum.”

Hayek shows in “Monetary Theory and the Trade Cycle” (available in pdf on Mises.org) that banks will temporarily dip below the 10% requirement during a boom, or at the start, in order to keep from having to raise interest rates to attract new deposits. In general, banks stay as close to the 10% minimum as possible, otherwise extra reserves are sitting in the vault not earning a return. During the downturn they may have more reserves because no one is asking for loans.

Grant: “I really don’t think any Austrians claim that ABCT is the only source of business cycles? ”

No. They mention war, drought, natural disaster and other things that people have understood as causing financial cycles for millenia. The ABCT seeks to explain the cycles that those phenomena don’t explain. In “Monetary Theory” Hayek includes a tech breakthrough as one reason that banks will begin to expand credit.

Here’s why credit expansion is necessary for a business cycle, but not necessarily a bubble. Assume a fixed supply of money. If prices start to rise in one commodity, people will have to reduce their consumption of something else in order to have the money to pay for the more expensive item. So you could have a bubble in a particular product, such as in the tulip mania in the Dutch Republic, without having a business cycle. But to have a general rise in business activity as we see in a typical business cycle, the money supply must increase.

In the current cycle, we saw a bubble in housing. If the money supply had remained fixed, then some other sector would have had a recession that mirrored the housing bubble. That didn’t happen. The lack of a recession in another sector indicates that the money supply was increasing enough to fund the housing bubble as well as keep all other sectors firing at the same time, such as the energy sector where prices increased as well.

Hayek goes through all of the explanations of business cycles and shoots them down one by one in “Monetary Theory and Trade Cycles”. There are two chapters that look at other theories, “Non-Monetary Theories of the Trade Cycle” and “Monetary Theories of the Trade Cycle.” As old as the book is, I have seen anyone come up with a theory not included in the book, which shows Hayek’s brilliance. He responded to economists who didn’t even write until after his death.

greg December 15, 2008 at 3:51 pm

Pinning the housing boom on the Fed’s management of money supply is really too simplistic. People not content on a 4% return on their investments searched for funds that offered 10% and were highly rated. They are still doing it, just look no further than Madoff!

We could debate the causes of the boom, which really was a boom in a few limited markets, and never hit on all the causes. What I really want to hear from someone from this school of thought, what is the solution to get us out of this present condition? And a realistic forecast of the effects of any solution put on the table.

My solution is simple. Every employer pays a matching FICA tax for every employee. When an employee buys a house, they submit the purchase and loan information to their employer and the employer sends their matching FICA tax to the bank instead of the government and this payment continues for 3 years.

While the government is going to collect less from employers, they will see their overall tax collection increase as the employee has less interest deductions, the people that make money on the real estate transaction and in the case of new construction, the amount of money that is made by all those that build the house. All those will pay income taxes as well as FICA taxes which will more than replace the money the government lost.

Eric December 15, 2008 at 4:09 pm

Greg, the FICA money is already going there. Since there is only one pot all the federal monies go to anyway. After all, there’s no SS lock box, except that it could be thought of as a box with a bunch of iou’s in it. All the FICA money has been spent long ago. To the feds, all taxes are really the same.

And, just because something sounds simple, doesn’t mean it’s wrong. Answer this question, where did all the money come from to go into the stock or housing bubbles. It either has to come from somewhere else (i.e. take from there), or more money is created.

If it came from somewhere else, there should have been areas that were slowing down as much as the bubbles were growing. Since there were not also great busts during the booms, this indicates that it was new money pumping things up.

After all, each time the prices increase (e.g. stocks, or houses) even more money is required to keep it going at the higher prices. This is why all it takes is a slight lowering of the speed of the money injections to cause a bust. You don’t need to stop inflating altogether, just slow it down some and those at the margins (the ones who couldn’t have stayed in business w/o the easy money) begin to fail. AKA, the bust.

Lucas M. Engelhardt December 15, 2008 at 4:19 pm


Some points about the multiplier:

First, “the multiplier is 10″ is a theoretical maximum based on obviously false assumptions. First, we assume that no currency is held by the public (so that the monetary base is only reserves). Second, we assume that all money that can be lent is being lent. Third (and this is rarely mentioned), we’re assuming that all deposits actually have a reserve ratio of 10%. These are all false.

In reality, a lot of the monetary base is held in currency nowadays. actually, as of December 2007, something like 95% was currency. Today, about 60% is. The larger this number is, the lower the money multiplier will look. (Though we can correct for this by just removing currency from both the money supply and monetary base, that would give us deposits/reserves again.) Say that there is $1 of monetary base, $0.50 in currency, $0.50 in reserves with maximum legal lending (10x reserves). Then we’d have a calculated multiplier of 5.5 instead of 10.

Also, in reality, as you note, not all money that can be lent legally is actually being lent. Banks generally hold some excess reserves… but not much, most of the time. Just looking over the past 60 years really quickly, actual reserves tend to be about 5-10% higher than required reserves. So, though the “maximum multiplier” may be 10, the “actual” one (if we only think about this impact) is closer to 9.

Both of these tend to push the money multiplier down below the theoretical level. They also allow the multiplier to fluctuate because of the behavior of banks and the public.

However, I would argue that the more important (false) assumption is the last one. In reality, 10% is the HIGHEST reserve requirement in a graduated, compartmentalized system. The first $X of deposits have a reserve requirement of 0%. The next $Y of deposits have a reserve requirement of 3%. It’s only dollars after $X+Y that have a 10% reserve requirement. Now, since banks tend to be very big, the 10% reserve requirement isn’t too inaccurate… for transactions deposits. But, there’s a very large set of “nontransactions deposits” which have a different reserve requirement… specifically, 0%. Right now, there are about $700 Billion in transactions deposits and over $6.5 Trillion in nontransactions deposits. The nontransactions deposits can be lent out, in their entirety, ad infinitim. Naturally, this would tend to increase the money multiplier above 10… perhaps far above 10, if it is appropriate to include these nontransactions deposits. Personally, I’d argue (as Rothbard did) that savings accounts should be included but time deposits should not. The savings account portion is about $4.4 Trillion.

As an exercise, I calculated the following: (True [AKA "Austrian"] Money Supply – Currency)/(Monetary Base – Currency). So, all the problems caused by having so much currency floating around will be cancelled out, and all that remains are the impacts of holding excess reserves and the fact that not all accounts have the same reserve requirements. For August, the number I got for this “true” money multiplier was 105. In fact, it had been over 100 since September of 2007. From 1981 to 1995, this number was right around 30-45, so 100 was HUGE. Right now? It’s just under 8. The Fed has injected reserves like mad, and the money isn’t getting loaned out (yet).

The lesson I’d pull from this: 10 isn’t too bad of a number for how much an addition $1 of reserves can create. If anything, it seems to be a conservative estimate.

Now, my interpretation of the data is somewhat different than Dr. Murphy’s… mostly because when I do my calculations, I see that reserves increased at the same time as the “true money multiplier” was increasing. So, part of the bubble was caused by Fed injections, but part a very large part was caused by public choices between transaction/nontransation accounts. (Transactions accounts barely moved which nontransactions accounts exploded.) This choice allowed for money to multiply much more than before. The big mystery in my mind is what changed in 1995 that caused the true money multiplier to start increasing then, as it increased very steadily from about 33 to 105 over the course of 10 years. That’s something I’m thinking about, but have no good answers for yet.

Another alternative calculation if you don’t like including savings accounts: To find the “actual reserve multiplier” calculate (M1-Currency)/Total Reserves. Making that calculation, the result is between 13 and 16 from 1981 until the past few months. So, 10 is still a conservative number for how much an additional dollar of reserves will multiply into. Really, it seems that the official multiplier is very heavily impacted by the fact that a lot of money is being held as currency rather than deposits. From my point of view, that’s good, as it minimizes credit expansion. On the other hand, with so many deposits in accounts with a reserve requirement of 0%, that “minimization” does almost nothing, as the multiplier on these deposits is theoretically infinite.

Anyway, just another perspective on that problem.

newson December 15, 2008 at 5:24 pm

grant/eric/dr murphy:

i think all this agonizing over the reserve multiplier is wasted energy. sweeps have made this calculation futile. see hatch article:

as for grant’s question as to why a particular sector becomes “hot”, my view is that initially plain old fundamentals kick in, and money flows to whichever sector was neglected in the previous bubble. austrian insights only predict the creation of the bubble, not where the bubble forms. that’s up to the market.

Pete December 15, 2008 at 7:54 pm

Lucas M. Engelhardt ,

Assuming a 10% required reserve ratio the money multiplier cannot go above 10. I don’t understand why you say reserves can be 0% and 3% at times. Please explain in further detail about non transaction deposits.


you said “What I really want to hear from someone from this school of thought, what is the solution to get us out of this present condition? And a realistic forecast of the effects of any solution put on the table.”

First we can start by getting the Government out of the mix, and end fractional reserve banking. This stops the manipulation of credit. When we first start this it will cause secondary effects that seem negative, but that is the market adjusting to real terms. Once we get back to a real economy we will see true prosperity.

N. Joseph Potts December 15, 2008 at 9:37 pm

Bob Murphy IS the best-looking Austrian. I’ve seen them all, and I know.
He’s nominated!

Grant December 15, 2008 at 10:50 pm

Lucas, thanks. You just reminded me (and others, I hope) that banking is way more complicated than most of us here know!

Pete, you cannot get the government out of banking and simultaneously end fractional reserves. That sort of banking has existed absent government intervention; to end it you’d probably need to outlaw it. I believe the era of free banking in Scotland, banks tended to have reserves of around 2-3%, but don’t quote me on that.

Christopher Richard Wade Dettling December 16, 2008 at 2:09 am

Very, very interesting …
I want to see how these numbers are connected to the spikes in oil prices and OPEC outputs.

Christopher Richard Wade Dettling

Inquisitor December 16, 2008 at 3:41 am

Pete, Lucas is right. The 10% is just a number commonly used. Many, many reserves are subject to even lower reserve requirements.

Lucas M. Engelhardt December 16, 2008 at 7:37 am


Legally, the Fed has different reserve requirements for different deposits.

“Transactions” deposits (which are mostly checking accounts) have a graduated system, not unlike the income tax structure. As of January next year,

The first $10.3 million has a reserve requirement of 0%. The next $34.1 million has a reserve requirement of 3%, and everything above the first $44.4 million has a 10% reserve requirement.

Nontransaction deposits – which includes all time deposits (think “Certificates of Deposit”) and most savings accounts (as long as the number of withdrawals is limited to some number each month… I think that’s 6 or less, with no more than 3 by check, but I’m not sure… it’s considered a “savings account”). These have a reserve requirement of $0.

So, say that you have a small bank with $100 million in savings accounts and $30 million in checking accounts. We can calculate the reserve requirements as:

$10.4m x 0% + $19.6m x 3% + $100m x 0% = .588m

So, on its $130 million of deposits, the bank is only required to hold $588 thousand dollars, giving a “true money multiplier” (deposits/reserves) of 221 for that particular bank, if they only hold required reserves.

Hope the example helps clarify things a bit.

Also, I tend to agree with you that we should “get the government out of banking and have a 100% reserve system”. The trick is “How?” I think that Rothbard has an answer: if we make banking legally equivalent to warehousing, then holding fractional reserves is fraud, and prosecutable. Currently, that’s not the legal status of banking. This switch can be done on a free market.

Also, I’d suggest that free banking would result in banks holding more reserves than they currently do. The current system has the FDIC, Fed, and high probability of bailouts all artificially reducing the cost of holding few reserves. So, even if we did have the government get out of banking and free banking resulted, we’d probably see more reserves than we do now. Naturally, though, this statement is somewhat speculative.

Joe Stoutenburg December 17, 2008 at 1:14 pm

While Lucas advanced the discussion well beyond the point, I wanted to clarify a simple matter of math. fundamentalist claimed that money only had to be lent out ten times to reach the maximum multiplier. You can verify this in a spreadsheet. Assuming a 10% reserve, the amount of money created equals

100 + 100 * 0.9 + 100 * 0.9 ^ 2 + … + 100 * 0.9 ^ n

Expressing this as a geometric series reduces the amount to

100 * (1 – 0.9 ^ (n + 1)) / 0.1

Here, n equals the number of additional loans made with the initial $100. For ten loans, a total of $686 has been created – nowhere near the maximum muliplier of 10.

Clearly, as n approaches infinity, the multiplier approaches 1 / 0.1 = 10. For a 10% reserve, the multiple approaches 9 with 20 additional loans and is virtually to 10 after 100.

Lucas M. Engelhardt December 17, 2008 at 3:59 pm


My response was directed at the earlier question offered by Grant. (“How often is the multiplier actually 10?”) My point was that even the theoretical “10″ we throw around is based on very false assumptions, and that the official calculations do not make reasonable adjustments based on the fact that these assumptions are false.

Joe Stoutenburg December 18, 2008 at 8:53 am

Lucas, thanks for the clarification. I did follow your points and found them very valuable. My intention was only to correct a very obvious mathematical error – that the amount of money created would equal the maximum after only ten rounds of loans.

For your illustrative bank, the effective required reserve is only 0.588 / 130 = 0.45%. Clearly, the money multiplier may quickly exceed 10 if this were typical of all banks. Indeed, plugging into the geometric sum formula I provided previously, we find that the multiple does indeed equal slightly less than 10 after only 10 rounds of loans at this lower reserve. However, it would require quite a few rounds to reach the theoretical maximum of 221. After 100 rounds, the multiple is still only about 80.5. After 1000 rounds, it is 218.7.

This is purely a mathematical exercise and is not intended to detract from your points.

Paul Marks December 19, 2008 at 3:43 pm

Dr Murphy had produced a fine article – one of which he should be justly proud.

On the question of exactly how much the banks and other such multiplyed the money that Alan Greenspan put into the system (in his various bailouts over the years):

It is hard to know the exact number – because Alan Greenspan (as was long noted by Ron Paul) ordered that M3 numbers no longer be published.

It is hard not to conclude that this was part of a policy of deception – of increasing the money supply to a vast extent whilst pretending to be a moderate (much like Central Bankers in the United States and Britain in the late 1920′s – who paid lip service to the “gold standard” whilst playing every trick to increase credit money).

The late Ayn Rand was right to put that dinner plate in Alan Greenspan’s face.

Trader December 25, 2008 at 10:43 am

Some thoughts:
1. The Greenspan inflation & the Greenspan “put”, whether in stocks, LTCM, Y2K, or even 911, encouraged:
— high risk taking; low to no down payments for all kinds of assets (esp. real estate;) securitization of various loans, etc.
All fostered/created bubbles.

2. When looking at monetary expansion during Greenspan years, I think it important to also consider the foreign Central Banks, esp. the carry-trade countries, such as Japan, who should also shoulder much of the blame.

Josh December 27, 2008 at 12:57 am

Maybe all the “extra” money came from stagnant wages and a declining employment:population ratio……But that would lead to a Marxist crisis of overproduction conclusion…..

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