Monetary Policy Ambiguities

The stance of monetary policy is confusing these days. The target Federal funds rate is near zero, but that's the nominal rate. With inflation low, the real rate cannot move as far into negative territory as it could if inflation were higher. It's not "zero bound," but it's much closer than usual.

I've always regarded monetary policy in terms of growth in the money supply rather than the level of interest rates. Many people insist on calling monetary expansion with low interest rates "quantitative easing," but to me it's just that money growth changes are a powerful tool. I don't know why a special term is needed.

The conventional wisdom is that money growth has exploded in recent months, and the growth in the Fed's balance sheet is the evidence usually cited. However, most of that balance sheet growth was over in December. We've gone almost six months with no further net growth in the balance sheet.

Among the monetary aggregates, the monetary base has grown very rapidly, but the M1 and M2 versions of the money have shown little net growth. Their growth rates went up, but then back down. The monetary base is not something that people spend on goods and services. It is not money, but rather the basis for money growth-bank reserves and currency. While growth in the monetary base is normally followed by growth in various measures of the money supply, times are not normal now. The Fed is paying a nominal interest on reserves, including excess reserves, and banks are seeking more liquidity than usual.  Therefore, bank reserves and the monetary base are growing without translating into money growth.

Dennis Robertson, years ago, wrote about "money sitting" and "money on the wing."

What we have now is bank reserves sitting and, to the extent new money has been created, money sitting. The velocity of money has dropped sufficiently that money growth has not translated into spending growth. New money doesn't stimulate the economy if it isn't spent.

So far, contrary to conventional wisdom, I have pointed out that, 1) the Fed's balance sheet has not grown, net, in almost six months; 2) the growth in the monetary base has not led to rapid money growth; and 3) the growth in the monetary base is not by itself simulative. The banks and the public are holding onto their bank reserves and money respectively.

Further complications in our understanding have been introduced by the recent rise in the yield on the 10-year bond. Traditionally, a rise in interest rates would be taken as a sign of monetary tightening, but the interpretation by many now is that it's a sign of "too much money being printed." That interpretation, I assume, means a new inflationary premium is being introduced into long rates.

That may be right, but an alternative interpretation, implicit in what I've said above, is that monetary policy is still rather tight and the tremendous increase in borrowing by the Treasury has led to higher rates. The public won't absorb all the new debt with out being paid to do so with higher rates. Right now, I think interest rates reflect excessive borrowing while the money supply is a better measure of Fed policy.

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  1. Jack B. McPherson says:

    We are on the pathway toward an apocalyptic financial disaster where the entire economy is on the brink of collapse. This will occur when taxation imposes intolerable loads and stresses on the private sector; when the bonded indebtedness of the federal government assumes proportions which exceed its ability to repay its obligations in a balanced and symmetrical manner; and when the prolific printing of money devalues its purchasing power and sets off inflationary spirals which will devastate the private market.

    The Gross Domestic Product is comprised of the sum total of the wealth produced by the intellectual and physical work of the private citizens as they labor and toil and go about their business within the scope of the free market. In the final analysis, wealth is not based on how much gold is on deposit at Ft. Knox but, rather, it is derived from the Gross Domestic Product which is the bedrock of the economy. It is the sustenance of our families and communities. It is the lifeblood of America. The federal government couldn’t exist without it.

    We are bearing witness to a free market overwhelmed with oppressive taxation, inordinate government intrusion, and the heavy burden of having to support a socialistic welfare state. If left unchecked, this will reach a degree where private business interests will lose the incentive to produce wealth which is the bedrock of the economy. At that point, the politicians and bureaucrats will become panic stricken for the reason that they will then be deprived of their ability to confiscate our private property for their personal use in funding their political aspirations, thereby leaving them with nothing other than their printing presses. Their power will dissipate like fog in the sunshine.

    Which brings us to the question, at what point will all of this federal spending, deficit borrowing, and printing of money overwhelm the GDP to the point where it becomes dysfunctional and government takeover of the economy takes place reminiscent of the central planning and collectivism of Stalinist Russia, and Maoist China? Everyone must draw their own conclusions when presented with this question.