The ballooning of central banks’ balance sheets in recent years has sparked fears of rampant inflation.

These fears stem from traditional monetary theory, which holds that an increase in central banks’ reserves will eventually lead to a rise in bank lending (and broad money), which in the end will lead to inflation.

This theory of the so-called “money multiplier” assumes monetary policy can influence broad money and inflation through central banks’ control of short-term interest rates and the monetary base of coins, paper money and central bank reserves.

But, as central banks’ largely failed attempts to control inflation through broad money in the 1970s and 1980s suggest, the money multiplier is too slippery to form the basis for policy rules.

Yet, despite its propensity to fluctuate, the money multiplier still matters. As IMF economist Manmohan Singh and his former colleague at the Fund, Peter Stella, say in a VoxEU note published last week, “its impact on how people think about monetary policy cannot be overstated”. Read more