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Why does an increase in narrow money not eventually lead to an increase in broad money?

In this question: Why doesn’t Japan’s central bank simply print more Yen to intentionally devalue the currency?, user EnergyNumbers tells me that Japan’s central bank did indeed attempt to print their way out of an over-valued currency, but the effort did not have the intended effect. EnergyNumbers explains that this is due to the differences in broad and narrow money.

EnergyNumbers explains that printing money only leads to an increase in narrow money, which is the most liquid component of a currency. For some reason, this does not cause the currency to devalue as expected, and EnergyNumbers suggests this is because there is not a corresponding increase in the supply of broad money, which is the least liquid components that make up a currency.

So the question is, why doesn’t the increase in the narrow money supply eventually lead to an increase in broad money?

Also, why doesn’t an increase in narrow money lead to currency devaluation?

Answer 746

There will be different effects in the short, medium and long terms.

Typically, in the long term, increases in narrow money might be expected to feed through to increases in broad money, and to devaluation pressure on the currency.

However, during a deflationary period, demand collapses, and increases in narrow money do not feed through into increases in broad money: if people are delevaraging, paying down debt, increasing savings, then the pressure on broad money is contractionary rather than expansionary. This can be reinforced by tighter bank-regulation causing them to increase their capital reserves, and be much more reticent about lending: again, these are all contractionary. If, on top of that, some government engage in fiscal contraction (e.g. UK, Italy, Greece), then the pressure on broad money is even more contractionary. These things can lead to a combination of reductions in broad money, and reductions in money velocity.

Although some narratives of money supply forecast that broad money results from increases in narrow money according to a money multiplier, analysis by Seth B. Carpenter and Selva Demiralp for the US Federal Reserve Board in 2010 found that the money multiplier was not a useful notion. There's also a paper (maybe from an Australian university) that found that increases in narrow money came after increases in broad money (I'll edit here later if I unearth that reference).

Looking at the UK money supply, there doesn't appear to be a direct causal relationship either away between narrow money (M0) and broad money (M4): graphs of UK M0 and M4, 2001-2006

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