By John M. Balder – All of us were taught in Economics 101 that central banks determine the money supply by using their high-powered (base) money and the multiplier. Both of these concepts should be tossed in the trash can. These notions are in error, as both the BOE and the Federal Reserve have recognized. In fact, central banks passively accommodate bank demand for reserves (as doing otherwise could prove disruptive to financial stability).
The influence central banks exert over money and credit creation is achieved via their control of short-term interest rates, and not via quantitative restrictions.
A quick aside here, I have always been curious as to why economists tend to focus so exclusively on the real economy, while choosing to ignore the financial system entirely. Similarly, my work in banking regulation in the early 1990s indicated that most regulators tended to ignore macroeconomic variables.
Is this a case of “where you stand on an issue is often a function of where you sit?” As one who participated in both endeavors, I have perpetually felt a need to connect macro with finance. This may be happening more today than it was 10 or 20 years ago, but it still has a long way to go. more>