The FRED graph above shows two different measures of money between 2005 and 2010: The red line tracks M2, which includes cash, checking deposits, and other short-term deposits. The green line tracks the monetary base, or M0, which includes only cash and bank reserves. The ratio of M2 to M0 (blue line) is often referred to as the “money multiplier,” a measure that describes how the supply of private money (deposits) responds to the monetary base: As banks accumulate excess reserves in their account, they expand their deposits and lending activities.
Between December 2007 and January 2009, M2 increased steadily but gradually, while M0 doubled from 837 billion to 1.7 trillion. As a result, the money multiplier dropped by half and has remained lower ever since.
Our second FRED graph separates M0 into its two components: currency (red line) and bank reserves (blue line). We see that the drastic change shown in the first graph is due to an increase in the supply of reserves following the 2008 recession. The increase in reserves is accompanied by a simultaneous change: The Fed began paying interest on excess reserves in October 2008. Had excess reserves brought no interest returns, banks would have expanded their deposit and lending activities because simply holding those reserves on the balance sheet is costly. Interest on excess reserves decreases the cost of holding them. As a result, banks are willing to hold more reserves relative to other assets, and they have less incentive to expand their balance sheet. This is likely to explain the decrease in the money multiplier. More detailed discussion about the phenomenon can be found in this article.
How these graphs were created: For the first graph, search FRED for and select “M2 (M2SL).” From the “Edit Graph” panel, use the “Add Line” tab to search for and select “Monetary Base; Total (BOGMBASE).” In the “Formula” field, type: a/1000 and select “Apply” in order to adjust the units. Next, use the “Add Line” tab again to search for and select “M2 (M2SL).” In the “Customize data” field, type “BOGMASE.” Then in the “Formula” field, type a/(b/1000) and select “Apply” to obtain the ratio of M2 to the monetary base. From the “Format” panel, under “Line 3,” set “Y-Axis position” to “Right.” Finally, adjust the time series to be from 2005-01-01 to 2010-01-01.
For the second graph, search FRED for a select “Monetary Base; Reserve Balances (BOGMBBM).” From the “Edit Graph” panel, use the “Add Line” tab to search for and select “Monetary Base; Currency in Circulation (MBCURRCIR).” Finally, adjust the time series to be from 2005-01-01 to 2010-01-01.
Suggested by Yu-Ting Chiang and Mick Dueholm.
