Michelle 11. Garfinkel and Daniel L. Thornton Michelle R. Garfinkel, an assistant professor at the University of California at Irvine, was a senior economist at the Federal Reserve Sank of St. Louis while this paper was written. Daniel L. Thornton is an assistant vice president at the Federal Reserve Sank of St. Louis. Richard L Jako and Scott Leitz pro- vided research assistance. HE MULTIPLIER MODEL of the money supply, originally developed by Brunner (1961) and Brunner and Meltzer (1964), has become the standard paradigm in macroeconomics and money and banking textbooks to explain how the policy actions of the Federal Reserve in- fluence the money stock. It also has been used in empirical analyses of money stock control and the impact of monetary policy actions on other economic variables. One important feature of tins model is that it decomposes movements in the money supply in- to the part that is due directly to Federal Re- serve policy actions (the adjusted monetary base) and the part that is due to changes in technology and the tastes and preferences of depository in- stitutions and the public (the money multiplier). In this decomposition, the multiplier is assumed to be independent of the policy actions of the central bank. The independence is implicitly predicated on the assumptions that the demands for both checkable deposits and currency are determined by the same factors, and that indi- viduals can quickly and costlessly alter their holdings of currency and checkable deposits to achieve the desired proposition of the two alter- native forms of money. 1 Open market purchases, for example, increase reserves and consequently checkable deposits; but the public simply shifts from checkable deposits to currency until the (unchanged) desired ratio of currency relative to checkable deposits is once again achieved. Be- cause policy actions have no impact on the pub- lic’s holdings of currency relative to checkable deposits, the multiplier does not depend directly on the policy actions of the Fed. This article investigates the theoretical and empirical validity of the key feature of the mul- tiplier approach. In theory, the multiplier is in- dependent of the policy actions of the Federal Reserve only if the demands for currency and checkable deposits are determined by identical 47 The Multiplier Approach to the Money Supply Process: A Precautionary Note I I ’ I I I I 1 The notion that the multiplier is independent of Federal Reserve actions—implicit in the work of Brunner and Meltzer (1964, 1968) and, more recently, in Plosser (1991) —has never been demonstrated rigorously with micro-eco- nomic principles. The argument presented here that would suggest such independence is implicit in works as early as Fisher (1911).