All measures of the US money supply have risen strongly over the last three months – see chart and text below for definitions. On the traditional monetarist view that money leads the economic cycle by about six months, this suggests US activity will stabilise and begin to recover from the second quarter.
The Federal Reserve embarked on “quantitative easing” – i.e. monetary base expansion – in September. However, the broadest money measure M2+ began to accelerate only after the Fed began to buy commercial paper in late October. In contrast to its prior operations, which relied on banks transmitting additional liquidity to the wider economy, this initiative injected cash directly into corporate bank accounts.
Commercial paper purchases have slowed recently but the Fed has started to implement a previously-announced plan to buy up to $500 billion of agency mortgage-backed securities (MBS). External investment managers acting for the Fed had acquired $53 billion of MBS by last Wednesday. To the extent that purchases are from non-bank investors, this operation will also have a direct positive impact on broad money. The Fed is likely to discuss further initiatives, such as purchases of Treasuries, at this week’s policy meeting.
Sceptics argue that monetarist optimism is misplaced because faster money growth is being offset by a decline in the velocity of circulation. Clearly, recorded velocity is falling but this reflects the lag between money supply changes and their impact on activity and prices and is not evidence that the Fed’s new policy will be unsuccessful. Monetary trends are a leading indicator of nominal GDP whereas velocity is, at best, coincident.
Definitions:
M1 = currency and checkable deposits
M2 = M1 plus savings deposits, small time deposits and retail money funds
MZM = money of zero maturity = M1 plus savings deposits and all money funds
M2+ = M2 plus large time deposits at banks and institutional money funds (my definition and calculation)
Note: M3 = M2+ plus repurchase agreements and Eurodollar deposits (no longer published)
