As discussed in Wednesday’s post, a pick-up in US real narrow money growth over June-August implies that the Fed’s decision to launch QE3 was at best otiose and at worst will prove destabilising. The rise appears to have gathered pace in September, judging from weekly monetary data. Six-month growth in the real money measure monitored here is on course to climb from 5.1% (not annualised) in August to 8.5-9%, the highest since January – see chart. (This estimate uses the average level of the nominal money supply in the first two weeks of the month while assuming that the six-month rise in consumer prices is unchanged from August.)
This strength cannot be attributed directly to the Fed, which contracted its balance sheet between March and early September. It reflects, instead, a voluntary decision by households and firms to shift funds into cash and checkable deposits from less liquid forms of money – such a shift usually precedes a rise in spending or financial investment. This decision, of course, may have been influenced by expectations that the Fed would deliver additional easing, thereby punishing savers further and raising the risk of future inflation, in turn increasing the incentive to spend now.
Allowing for the typical half-year lead to demand / output, the monetary surge will hit in early 2013 as the economy simultaneously negotiates a “fiscal cliff” of uncertain steepness – this will be determined in political wrangling after the November elections. The ideal scenario, of course, would be for money-signalled stimulus exactly to offset fiscal restraint, resulting in stable economic expansion. The bias here is to view the monetary boost as more powerful, particularly with the Fed pouring fuel on the flames and a rising (though currently still low) probability of a Democratic clean sweep in the elections – this would allow a swift deal on the “cliff”, though at longer-term fiscal cost.
The concern, however, is that nominal GDP buoyancy in early 2013 due to the current monetary surge will be reflected in inflation rather than economic activity. The “transmission mechanism” would be further strength in commodity prices enflamed by the Fed’s over-activism and an imbalance between demand and supply early next year, with firms unprepared for a pick-up in spending because of exaggerated concern about the impact of fiscal restraint. Yet again, incompetent, short-termist policy-making risks wrecking a promising economic outlook.