Something dramatic is going on with the official money supply statistics, but its significance is hard to interpret. For a long time, even as the Federal Reserve pushed short term interest rates to very low levels, the broad measure of money, M2, grew only around 5 percent per year. While a Keynesian focus only on interest rates caused most observers to think of monetary policy as very easy, a Milton Friedman type monetarist might have argued that monetary policy was too tight for the circumstances.
A few months ago, M2 growth suddenly accelerated. In the Federal Reserve’s latest H.6 release, as of October 10, M2 growth for the latest 3 months through September had accelerated to 21.1 percent, pulling up the 6 month growth rate to 14.6 percent, and the yearly growth rate up to 10.1 percent. The less important M1 numbers for those three periods respectively were 38.2 percent, 25.7 percent and 20.4 percent. These were sudden and dramatic increases. When I first noticed them, I felt relief that banks were finally satisfied with their holdings of excess reserves and were finally stepping up their deposit (and money) creating loans and investments. My friend, David Malpass, an excellent economist, suggested to me a darker explanation: that deposits were accumulating, not because of more bank lending, but because the lack of attractive alternatives had caused people to park their money in very low yielding bank deposits. This imfers a shift in the public’s assets from outside the M1 and M2 measures of money to assets inside those measures, without much significance.
This conundrum may also be viewed in terms of the significance of the behavior of the monetary base, which is a combination of bank reserve deposits at the Fed (both required and excess) and currency outside the banking system. The bloating of the base in recent years has been caused primarily by the rapid growth in banks’ excess reserves. Those who rely on past relationships between the monetary base and economic activity have taken the rapid growth in the base as portending very rapid inflation. Those, like me, who think you shouldn’t count the excess reserve component of the base growth, have been less concerned. While this is just armchair theorizing, I did recently meet an economist who constructed his own private measure of the monetary base that excluding excess reserves.
While Fed surveys suggest that lending standards at banks have eased somewhat recently, leading to increased bank lending, the Malpass view seems to be the prevalent view. Today, in an article beginning on the front page of the New York Times, its authors assumed and concluded that the rapid expansion of bank deposits lately had little or no contribution from more bank lending but was entirely a result of lack of better alternatives for parking money. So, my earlier optimism regarding the pick-up in money growth appears to have been premature.
On the other hand, the cause of the buildup of very liquid deposits may not determine entirely the result. Consumers and businesses hold a variety of financial assets, ranging from the most liquid M1—coin, currency and checking accounts—on the one hand to less liquid assets—Treasury securities, bank CDs with a penalty for early withdrawal, for example. The question for the economy is whether a shift of those assets toward the more liquid might affect spending. There is nothing magic about the definition of M2, but it is a much broader measure of money than M1. Much of the shifting of assets into bank deposits described in the New York Times article could well have been shifts within M2, and made no contribution to the recent explosion of M2 growth.
[For the record, M2 includes M1, plus savings deposits, including Money Market Deposit Accounts, time deposits under $100,000 (excluding IRAs and Keogh accounts), and retail money market mutual funds.]
Definitions aside, the “moneyness” of financial assets logically increases with their liquidity; so regardless of the motive for the increased growth in the monetary aggregates, they are more likely to stimulate aggregate demand than to reduce it, a low expectation consistent with recent experience.