As argued in previous posts, current exceptional circumstances justify action by central banks to boost broad money supply growth to 10% or so temporarily in order to support an economic recovery. For this reason, the asset purchase schemes introduced by the Federal Reserve last autumn and the Bank of England this month are welcome.

The scale of the expansion of the Fed’s buying programme announced yesterday, however, threatens to push money growth well above 10% for a sustained period. While US recovery prospects are further enhanced, so is the medium-term risk of higher inflation and market disruption as the Fed is forced to withdraw unprecedented liquidity support at short notice.

Since last autumn the Fed has bought $241 billion of commercial paper, $44 billion of agency securities (i.e. issued by Fannie Mae, Freddie Mac and the Federal Home Loan Banks) and $217 billion of agency mortgage-backed securities (MBS). The total of $502 billion amounts to 6.1% of the M2 money supply and 4.4% of the broader money measure discussed in an earlier post.

The Fed had scope to buy a further $339 billion of agency debt / MBS under previous plans. It has now expanded the buying programme by up to a further $1.15 trillion, comprising $100 billion of agency securities, $750 billion of MBS and $300 billion of Treasuries. Future purchases could therefore total $1.489 trillion – 18.0% of M2 or 13.0% of broad money.

M2 grew by 9.8% in the year to February, while the broad money measure rose by 6.5% during 2008. The Fed may not utilise its full buying potential but if it did annual M2 / broad money growth could rise to 15-25%. Such rapid expansion is neither necessary for an economic recovery nor desirable for medium-term inflation and market stability.