state-dependent relationship of money multipliers : A new look at the money creation process

Purpose: The traditional theory of money multipliers states that bank lending is done on the assumption that banks have borrowable funds due to the accumulation of deposits. Most studies related to the credit creation theory attribute the trend of increasing the money ratio and expansion of the money supply largely to the behavior of banks. Above all is the behavior of private individuals through their demand for bank credits. In fact, the latter begins the process of creating money. Given the willingness of banks to lend, if demand for credit is weak, the lending rate and, thus, the increasing money rate will inevitably be low. In this study, following recent studies in this field and for the first time, the behavior of the increasing monetary coefficient in the Iranian economy is analyzed contrary to traditional views. To this end, the role of demand for loans is explained in the process of money creation, and this provides new policy implications.
 
Methodology: In this study, the nonlinear co-integration between the increasing liquidity coefficient and the increasing lending coefficient is expressed through the Granger and Lee threshold cointegration model. To model the relationships of the increasing monetary coefficients and the real output growth rate with respect to the change of time series behavior, the Markov State Dependent Switching Garch (MSGSRCH) time series is employed. In order to analyze the behaviors dependent on the situation of the increasing coefficient and to use the statistical database of the Central Bank of the Islamic Republic of Iran, the seasonal data on the variables of money volume (M1), liquidity (M2), monetary base (MB), total bank deposits (D), loan rate and banking network credit (L), bank reserves (ER) and real GDP (Y) are extracted for the time period of 1978-2021.
 
Findings and Discussion: Using a threshold aggregation process, the long-term nonlinear relationships of increasing the lending ratio and increasing the liquidity ratio are confirmed. The results show that, in the Iranian economy, an increase in the lending ratio is the Granger cause of an increase in the liquidity ratio, and the effect of increasing the liquidity ratio is asymmetric. Finally, the results of the tests show that the adjustment for the long-term equilibrium of the increasing liquidity coefficient is quite asymmetric and meaningful. Also, the results of examining the relationship between different increasing coefficients and economic growth show that, in the recession regime, all increasing monetary coefficients have a negative and significant effect on economic growth. With the regime rotating and being in the boom period, the increasing money coefficient and the increasing lending coefficient have a small but significant positive effect on economic growth. Comparing the mean and estimated coefficients of the models shows that, in the case of the increasing lending coefficient, the mean of the regimes is significantly higher than the increasing coefficients of money and quasi-money.
 
Conclusions and Policy Implications: The results of this study in the field of increasing monetary coefficient behavior show that, although the traditional approach of increasing monetary coefficient is still in use and policymakers and economists continue to emphasize this approach in controlling liquidity and consequently anti-inflationary policies, it seems that this approach is inadequate in a variety of ways. This research confirms the results of previous studies such as Saqza and Morley (2022), Goodhart (2017) and Carpenter and Demiralop (2012). We emphasize the fact that it is the demand for loans rather than the supply of loans that plays a decisive role in the process of money creation by banks. The process of creating money will not stop until the demand for loans is limited and the society reduces its demand for loans for certain economic reasons, including high inflation, which is mainly the result of fiscal policies and financial indiscipline. As Goodhart (2017) points out, instead of claiming that banks create credit, and then such loans create money, it is closer to the truth to say that the private sector creates credit and money for itself, and that the banking sector is an intermediary that uses private sector customers to do so on the terms and conditions set by banks. However, the central bank of Iran has adopted policies in recent years aimed at limiting access to bank credits to slow down the pace of money creation. Despite the shortcomings of the bank credit market, the demand of the private sector for bank loans has increased due to high inflation. Monetary policymakers can control this cycle to some extent by implementing policies and restrictions, but the implementation of such decisions by the central bank is temporary because, despite the implementation of mandatory policies and strict controls on the supply of credit and credit as well as due to the very high demand for credit, there is no possibility of implementing restrictions by the central bank in medium and long terms. Besides, governments do not support the implementation of such policies due to the severe financial constraints of companies in these circumstances.
It seems that reforms in the money creation cycle and the analysis of the current conditions of the Iranian economy need a serious revision. Attention to the traditional approach of increasing monetary coefficient (minimum) is not enough. Instead of focusing solely on controlling the M1 or monetary base and solely on the sources of money supply, it is better to focus on controlling the demand for loans and credit from the society. The behavior of individuals and companies in this regard requires special attention. The current conditions of the Iranian economy and the existence of high inflation have also sharply increased the demand for loans from the society. Controlling inflation and its roots seems to be inevitable from a non-monetary perspective to control demand for loans and credits.