Where’s the Money?

What am I missing? I keep hearing people on financial TV say things like “The Fed keeps pumping out the dollars,” “The Fed keeps monetizing the debt.”

Then I go look up money-growth charts. I can’t find all this excessive money creation that is monetizing the debt and is about to create a breakout in inflation. Not M1; not M2.

In desperation, I went to the Fed’s H-6 money supply series and committed some arithmetic. As of April 2010, the seasonally adjusted annual rate of M1 growth was 5 percent over the past 3 months; 3.1 percent over the past 6 months and 6.8 percent over the past 12 months. The seasonally adjusted annual rates of M2 growth were respectively -3.1 percent, -0.2 percent and 1.6 percent.

These are hardly excessive growth rates in normal times, much less in an economy with almost 10 percent unemployment, with capacity utilization down from the 80s to the 60s, and with nonbank credit sinking, productivity growing rapidly, and with unit labor cost declining.

Where is all this money we keep hearing about?

Surely all these people don’t mean the monetary base, which spiked as the Fed grew its balance sheet, primarily during the crisis period at the end of 2008. The most common measure of the Monetary Base is bank reserves plus currency outside the banking system. The monetary base used to be called “high-powered money” because bank reserves normally support bank deposit money equal to a multiple of itself. The monetary base has been treated, not as money itself, but as the raw material from which money is created.

But everybody knows that banks have been holding reserves as “excess reserves” as an asset on their balance sheets. The Fed’s asset expansion, resulting from its loans to financial institutions and purchases of securities, mainly mortgage-backed securities, have been matched by growth in monetary liabilities, but those liabilities have not been used by banks to create deposit money through bank lending and investing.

As I was looking for an explanation for why people keep talking about excessive money growth and its inflationary potential, I ran across someone defining inflation as money growth—not inflation caused by money growth, but inflation defined by money growth. I’ve heard that occasionally on financial TV as well. Go figure.

To repeat the obvious, because others won’t, money growth is almost flat. Flat money growth does not cause inflation—especially when we have enormous slack in the economy along with rapid productivity growth and declining unit labor cost. We may get inflation in the next few years, but, if so, it will be based on money growth yet to happen. It hasn’t happened yet.

Comments (9)

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  1. Jon says:

    Well put.

  2. Ikenstein says:

    This really is a creative way to justify the fed’s policy of debasment.

    ‘Sure, we’ve doubled the monetary base, but because banks haven’t multiplied it by ten and lent it out it isn’t money!’

    The fed publishes stats showing that the US money supply is growing at a phenominal rate.


    And price inflation is huge. See, for example


    Is the price of a liter of gas the same now as it was in 2008? Maybe you can start your search for price inflation right there.

  3. Tony Vossman says:

    Given the dollar’s globalization over the last fifty years, and it’s prevalence as a peg and “safe-haven” for both the honest and the unscrupulous, I think that naive quantity theory has little value as an indicator of inflationary risk anymore. Certainly not as a leading indicator. M1 & M2 are vague guesstimates, and the former M3 is an intangible scientific curiosity.

  4. Joe Calhoun says:

    Mr. McTeer,

    The Federal Reserve Bank of Cleveland produced a paper in 1997 on the origin and evolution of the word inflation in modern times (can’t find it online but I have it some hand written notes; authors name was Bryan). It first entered the lexicon in the mid 1800s and was generally understood to refer to an expansion in the supply of paper currency that was not backed by precious metals. The usage changed around the turn of the century to refer more to the rise in prices that was the result of the money supply expansion. Keynes pretty much cemented the term to mean a general rise in prices with his (quite muddled in my opinion) monetary writings in the twenties.

    As I’m sure you know, the Austrians tend to define inflation in terms of an increase in the supply of money and/or credit that is in excess of the demand, i.e. an equilibrium approach.

    So anyway, that brings me around to my point. Milton Friedman said that inflation was always and everywhere a monetary phenomenon. Given the equilibrium type definition above it seems to me that inflation could just as easily be a fiscal phenomenon since demand can and often is determined to a large degree by policies other than monetary. My point is that to get inflation as you define it (rising prices) merely requires that the politicians do something quite stupid that reduces the demand for dollars. They seem well on the way to accomplishing exactly that.

  5. Joe says:

    The Cleveland Fed paper Joe Calhoun may be referring to is this article by Michael F. Bryan and Christopher J. Pike, from 1991 http://www.clevelandfed.org/Research/commentary/1991/1201.pdf
    Samuelson, the textbook writer, also contributed to the confusion over inflation. Remember “wage push” inflation? In his Principles, Samuelson talked about an increse in the price of a factor of production (wages, due to union power, or more recently oil, due to OPEC)supposedly affecting the prices of all goods for which it is an input. But without monetary inflation, the prices of other inputs fall (because of lower quantity demand) if the price of one good rises. This is the Austrian, and I think, monetarist view.

  6. Joe Barnett says:

    Here is the specific article on the word inflation, also by Michael F. Bryan, published by the Cleveland Fed:

  7. Joe Calhoun says:

    Thanks for the link Joe Barnett. I had the article saved on my computer but couldn’t find the link. Interesting stuff.

  8. Emily says:

    Here is the specific article on the word inflation, also by Michael F. Bryan, published by the Cleveland Fed:

  9. Bob McTeer says:

    Interesting and thoughtful dialog.

    Yes, I do define inflation as an increase in the general price level. I understand that early definitions defined it in terms of monetary expansion. But one of my points is that there hasn’t been that much monetary expansion, if you define money as M1 or M2. There has been a large increase in the monetary base, which traditionally, has led to monetary expansion and may eventually do so this time around, but not yet. The break in the link, so far, has been banks holding the reserves that have been created as excess reserves–obviously because they are very nervous and want an extra cushion.

    All that has happened may eventually lead to rapid inflation–by my definition–but that has yet to be determined. It hasn’t so far. It hasn’t even if you define inflation as an increase in the money supply. If you define inflation as an increase in bank reserves, or the monetary base, then it has, by definition.

    What the Fed has done may “debase” the currency ordinarily, but I would submit that under recent circumstances it prevented deflation.

    Anyway, good discussion. Thanks.