Alternative Approaches to Money Multiplier

The recent financial crisis ignited a reexamination of the mechanism of money creation and the determination of money supply. With the perspective of credit creation by banks, we find that prudential regulations constrain money creation capacity of banks, and based on which we can derive at formulas of money multiplier. This approach is established on the structure of bank balance sheets, which together with regulatory requirements and environment of banking determine the money supply. To make it more realistic, we propose a stock-flow consistent model, which characterizes the interaction between banks and the non-bank public in terms of monetary flows. The dynamics of the stocks related to money creation are formulated and the steady-state solutions are solved, from which the expression of money multiplier can be obtained. We further make a comparative analysis of these two methods in terms of derivation, precondition, and formula, yielding a reconciliation of both approaches. This comparison not only clarifies the determinants of money supply, but also can help us in designing effective regulatory and monetary policies.