Thomas Tooke

The best explanation of the multiplier ever. The hoarding of money and drop in multiplier requires some offsetting mechanism.

In Uncategorized on January 8, 2013 at 2:10 am

It is sometimes misunderstood that the Fed increases the amount of idle money and “it does not work” because the multiplier drops. The reality is that it is the drop in the multiplier which requires the increase in idle money. The best explanation the writer of this blog is old. It dates from 1802 from Henry Thornton but everything comes clear.

In 1802, Henry Thorton wrote.

” The quantity of circulating paper, that is, of paper capable of circulation, may be great, and yet the quantity of actual circulation may be small, or vice versa. The same note may either effect ten payments in one day, or one payment in ten days; and one note, therefore, will effect the same payments in the one case, which it would require a hundred notes to effect in the other.

The cause which lead to a variation of the rapidity of the circulation of bank noes may be several. In general, it may be observed, that a high state of confidence serves to quicken their circulation; and this happens upon a principle which shall be meant a more or less quick circulation of the whole of them on an average. Whatever encreases that reserve, for instance, of Bank of England notes which remains in the drawer of the London banker as his provision against contingencies, contributes to what will here be termed the less quick circulation of the whole. Now a high state of confidence contributes to make men provide less amply against contingencies. At such a time, they trust, that if the demand upon them for a payment, which is now doubtful and contingent, should actually be made, they shall be able to provide for it at the moment and they are loth to be at the expence of selling an article, or getting a bill discounted, in order to make the provision much before the period at which it shall be wanted. When, on the contrary, a season of distrust arises, prudence suggests that the loss of interest arising from a detention of notes for a few additional days should not be regarded. It is well know that guineas are hoarded, in times of alarm, on this principle. Notes, it is true are not hoarded to the same extent; partly because the class of persons who are the holders of notes is less subject to weak and extravagant alarms. In difficult times, however, the disposition to hoard, or rather to be largely provided with Bank of England notes, will, perhaps, prevail in no inconsiderable degree. This remark has been applied to Bank of England notes, because these are in high credit; and it ought, perhaps, to be chiefly confined to these. They constitute the coin in which the great mercantile payments in London, which are payments on account of the whole country, are effected. If therefore, a difficulty in converting bills of exchange into notes is apprehended, the effect both on bankers, merchants, and tradesmen, is somewhat the same as the effect of an apprehension entertained by the lower class of a difficulty in converting Bank of England notes or bankers´ notes into guineas.

The apprehension of the approaching difficulty makes men eager to do that to-day, which otherwise they would do t0-morrow. The truth of this observation, as applied to Bank of England notes, as well as the importance of attending to it, may be made manifest by adverting to the events of the year 1793, when through the failure of many country banks, much general distrust took place. The alarm, the first material one of the kind which had for a long time happened, was extremely great. It does not appear that the Bank of England notes, at the time in circulation, were fewer than usual. It is certain, however that the existing number became, at the period of apprehension, insufficient for giving punctuality to the payments of the metropolis; and it not the be doubted, that the insufficiency must have arisen, in some measure, from that slowness in the circulation of notes, naturally attending an alarm, which has been just described. Every one fearing lest he should not have his notes ready when the day payment should come, would endeavour to provide himself with them somewhat beforehand. A few merchants, from a natural though hurtful timidity, would keep in their own hands some of those notes, which, in other times, they would have lodged with their bankers; and the effect would be, to cause the same quantity of bank paper to transact fewer payments, or, in other words, to lessen the rapidity of the circulation of notes on the whole, and thus to encrease the number of notes wanted.

Probably, also, some Bank of England paper would be used as a substitute for country bank notes suppressed. The success of the remedy which the parliament administered, denotes what was the nature of the evil. A loan of exchequer bills was directed to be made to as many mercantile persons, giving proper security, as should apply. It is a fact, worthy of serious attention, that the failures abated greatly, and mercantile credit began to be restored, not at the period when the exchequer bills were actually delivered, but at a time antecedent to that aera. It also deserves notice, that though the failures had originated in an extraordinary demand for guineas, it was not any supply of gold which effected the cure. That fear of not being able to obtain guineas, which arose in the country, led, in its consequences, to an extraordinary demand for banknotes in London; and the want of bank notes in London became, after a time, the chief evil. The very expectation of a supply of exchequer bills, that is, or a supply of an article which almost any trader might obtain, and which it was known that he might then sell, and thus turn into bank notes, and after turning into bank notes might also convert into guineas created an idea of general solvency. This expectation cured, in the first instance, the distress of London, and it then lessened the demand for guineas in the country, through that punctuality in effecting the London payments which
it produced, and the universal confidence which it thus inspired. The sum permitted by parliament to be advanced in exchequer bills was five millions, of which not one half was taken. Of the sum taken, no part was lost. On the contrary, the small compensation, or extra interest, which was paid to government for lending its credit (for it was mere credit, and not either money or bank notes
that the government advanced), amounted to something more than was necessary to defray the charges,and a small balance of profit accrued to the public. ”

COMMENT: Obviously from this account it is the hoarding of medium of circulation because of apprehension which creates a reflexive higher level of hoarding of medium of payment and circulation and a reflexive debt deflation. By that token the increase in medium of payments does not increase in any way inflation, but just compensate for the state of idleness of the economic agents. In that sense one could say that the printing from Central banks increases in no way inflation but just offset the hoarding of medium of exchange. However when confidence comes back (higher inflation expectation), the removal of the excess injections of mean of payment if too slow can help get the inflation that the government desires to inflate its debts away. So the inflation does not occur during the hoarding but during the timid exit. Another point is that in the 1793, the sovereign lent its credit to issue exchequer bills which would be used as collateral for the restoration of commercial credit. What happens when the sovereign´s credit has been tarnished, are all the proverbial bullets been shot? Finally the promise of liquidity action was as much potent as the actions themselves, was Mario Draghi taking a page from Henry Thornton´s account of the 1793 crisis?


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