According to Scott Fullwiler, Associate Professor of Economics at Wartburg College , the money multiplier model is not just broken but is obsolete. B anks do not lend based on what they have in reserve. They can borrow reserves as needed after making loans. Whether banks will lend depends rather on (a) whether they have creditworthy borrowers, (b) whether they have sufficient capital to satisfy the capital requirement, and (c) the cost of funds -- meaning the cost to the bank of borrowing to meet the reserve requirement, either from depositors or from other banks or from the Federal Reserve.
Setting Things Right
Whatever is responsible for causing the local credit crunch, trillions of dollars thrown at Wall Street by Congress and the Fed haven't fixed the problem. It may be time for local governments to take matters into their own hands. While we wait for federal lawmakers to get it right, local credit markets can be revitalized by establishing state-owned banks, on the model of the Bank of North Dakota (BND). The BND services the liquidity needs of local banks and keeps credit flowing in the state. For more information, see here and here.
Concerning the gaping federal deficit, Congressman Ron Paul has an excellent idea: have the Fed simply write off the federal securities purchased with funds created in its quantitative easing programs. No creditors would be harmed, since the money was generated out of thin air with a computer keystroke in the first place. The government would just be canceling a debt to itself and saving the interest.
As for "quantitative easing," if the intent is to stimulate the economy, the money needs to go directly into the purchase of goods and services, stimulating "demand." If it goes onto the balance sheets of banks, it may stop there or go into speculation rather than local lending -- as is happening now. Money that goes directly to the government, on the other hand, will be spent on goods and services in the real economy, creating much-needed jobs, generating demand, and rebuilding the tax base. To make sure the money gets there, the 1935 law forbidding the Fed to buy Treasuries directly from the Treasury needs to be repealed.
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