Who Killed the M1 Money Multiplier --- and HOW and WHY!

I've been wondering about this for a while.

In comments here, reader nanute points me to the villain.

It is The Fed.

They do it by paying interest on excess reserves.

The reason is to prevent inflation.

Holy shit!   We are stumbling at the edge of deflation, and the Fed is fighting inflation.

I'm no economist (so somebody help me out here if I'm all wrong) but it seems to me that if the $1 Trillion, or so, being held in excess reserves were released into the economy, we would have no need for QE II.  And the $600 billion that the Fed is going to magically create via QE II will probably just  result in there being about $1.6 Trillion in excess reserves by next Summer.

Now, I must go hug a squid.

Update:  In comments, nanute fine-tunes the thinking.

I think the larger problem that is concerning the Fed and driving this policy is the fact that the major financial institutions are being permitted to carry high risk assets (think mbs, derivatives, etc.) at face value. I've argued for quite some time that allowing this change in policy to continue only prolongs the inevitable, and is the primary reason why the economy remains anemic. Until policy makers and financial institutions come clean, and flush all the bad debt from the system, no meaningful recovery can occur.

I do realize that such a severe shock to the system may in fact make things worse in the near term, but unless and until the individuals responsible for creating the mess are required to pay for the damage without taxpayer assistance, we will continue down the road of high unemployment and lack of demand for goods and services.

Robert Prechter pointed out years ago that debts must be repaid - If not by the borrower, then by the lender.  The third possibility is pass it off to the general population.  This is a drag on the system whose effects are difficult to calculate.  Talk about your dead-weight losses.

It's easy to believe that this is part of why the American economy has come undone.  Another thing Prechter has pointed out is that we get less bang for the debt buck now than in the past, and this mill stone could be part of the reason why.

Where I disagree with nanute is that I don't specifically relate this to the M1 collapse.  I think the case for the Fed's responsibility made at Washington's Blog is pretty compelling.
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