Thursday, March 25, 2010

Why Inflation Concerns Are Overblown: Annual M2 Growth Falls Below 1%, Lowest Rate Since 1995

Federal Reserve data show that the M2 growth rate on an annual basis fell in the week ending March 15 to 0.85%, the lowest money growth rate since May 1995 (see graph above). Notice also in the graph above that M2 growth in 2001 was actually above 10% for a longer period of time, than the money supply growth in early 2009. Further, there has been a much sharper decline in money growth in the last year than the decline between 2002 and 2005, when the growth rate fell but never went below 2.5%. In each of the last 10 weeks, M2 growth has been below 2.5%. Considering that average annual inflation never got higher than 3.4% in 2005 following the 10% M2 increase in 2001, so it just doesn't seem like there's enough money growth to create inflationary pressure now, at least nothing higher than maybe 3%.

Dallas Fed President Robert McTeer seems to agree in his Forbes article "Why Inflation Worries Are Overblown":

"It will no doubt come as a surprise to many that money growth has been moderate since its initial explosion at the end of 2008 (see chart above). That’s because they hear so much about the expansion of the Fed’s balance sheet, which would normally imply an expansion of bank reserves and money. Fed assets have more than doubled with virtually all the increase taking place in late 2008. The asset expansion has produced a sharp rise in bank reserves, and hence the monetary base, which is composed of bank reserves and currency outside the banking system.

However, banks have not used those reserves to expand loans and investments at a rate large enough to produce rapid money expansion. Instead, banks have accumulated reserves far in excess of the amount required to back their deposit liabilities. This accumulation of “excess reserves” is no doubt the result of banker uncertainty and fear about their viability during the period of crisis. In particular, banks are remaining more liquid than regulations require to protect their remaining capital. Virtually all of the expansion in the Fed’s assets are matched by an expansion of excess reserves—excess from a regulatory standpoint, but obviously not excess to the bankers themselves since they are holding them voluntarily."

Updates: Thanks to Scott Grannis for his most recent M2 post here from earlier today, and for adding one additional week of money supply data that doesn't appear at the St. Louis Fed website, but does appear here at the Fed. The growth rate in M2 in the week ending March 15 was 0.85%, the first time since May 1995 of M2 growth below 1%.


At 3/25/2010 10:21 PM, Anonymous Anonymous said...

Sure it is just fine now. They have already done their expansion so why would they have to do more now. The subprime loans were no problem at all in 2002, 2003, 2004, 2005, 2006. It did not start to hit the fan until 2007. Don't worry about a thing. Everything is fine. Social Security and Medicare for 79 million baby boomers is guaranteed. Cheap mortgages for homes are guaranteed. Health care for another 30 million Americans is guaranteed. We have low inflation, money in the bank and no inflation. Life is great. Sleep soundly.

At 3/25/2010 10:40 PM, Blogger Cabodog said...

Plenty of banks are also stockpiling capital to allow them to buy failed banks. Why lend -- it's too risky and easier to buy assets guaranteed by the FDIC.

At 3/25/2010 11:17 PM, Blogger Scott Grannis said...

See my related commentary on this subject, to the effect that a slowdown in M2 growth is not inconsistent with an increase in inflation.

At 3/26/2010 12:45 AM, Anonymous sprewell said...

Pegging inflation to M2 growth alone is not the right analysis, because as McTeer says, that money can sit in bank reserves or it can be lent out. The problem is that it's somewhat straightforward to measure supply but very hard to measure velocity, and you need both. To explain, I'll make a comparison to the past with the gold standard. Suppose Hearst discovered a large new gold vein but hoarded all the gold in his warehouses or banks. That's a lot more "money" available to be used, but until he starts using it, it will not affect prices. That usage vs storage is what is hard to measure with velocity.

To be fair to the inflation hawks, their fear is that as the economy recovers, the money in storage will be lent out in spades and Bernanke will not be strong enough to mop up the excess reserves because of political pressures against doing so. I give Ben more credit than that, but acknowledge that it can be a hard decision for him to make. Looking at Scott's linked graph, an alternate hypothesis to his likely incorrect one about an inverse correlation is that M2 growth drives CPI with a delay, though a better comparison would be the Fed Funds target rate to CPI. The fundamental problem is that our current money supply is fairly antiquated and hard to measure, so there's a lot of pontificating about what will happen without much useful data available to rely on.

At 3/26/2010 6:07 AM, Anonymous geoih said...

Too bad M2 doesn't count all of the money reserves actually in the banks. Start counting that and you'll add about a trillion dollars to the account sheet.

The magic of government statistics is all in how you count.

At 3/26/2010 7:55 AM, Anonymous morganovich said...

core inflation ex shelter is already tracking over 2.5% (and rising rapidly)

granted, once you leave out food, energy, and rent, well, that's most stuff, but if you put all 3 back in, the number isn't that different.

you guys watching bong yields?

up pretty sharply this week.

At 3/26/2010 10:23 AM, Blogger Benjamin Cole said...

Inflation? Fugetaboutit.

Wages? No. Manufactured goods (outside military hardware)? No. Real estate? Double no.

Besides, if we have a globalized economy, should we not be concerned with global monetary growth?

Does anyone obsess over the monetary supply, say, in California? Of course not--too much fluidity between CA and the other states.

But with globalization, does the global money supply become increasingly important?

Why or why not?

BTW don't bother looking for global money supply stats. It is the gong show out there....

At 3/26/2010 10:34 AM, Blogger juandos said...

"Why Inflation Concerns Are Overblow[n]"...

Hmmm, really?

I wonder what Robert McTeer would then make of this latest CBO analysis of Obama's budget?

This makes for some heady reading:
CBO Director Elmendorf's letter to Sen. Inouye of Senate Appropriations Committee

At 3/26/2010 11:46 AM, Blogger Methinks said...

give it a few years, professor. When China revalues its currency by not buying so much U.S. debt, our interest rates rise and we begin monetizing in earnest.

Sure, we can hope some other major economy explodes, making us relatively good looking in a contest of ugly girls. But, living on a hope and a prayer you won't collapse is tumbling on some pretty thin ice.

Zimbabwenomics never leads to anything good.

But, you know this, so I'll shut up now.

At 3/26/2010 11:49 AM, Blogger Methinks said...

you guys watching bong yields?

That made me laugh, Morganovich. I'm not entirely sure it was a typo!!

That auction may have made you want to break out the bong.

At 3/26/2010 3:25 PM, Anonymous morganovich said...


i'm more a fifth of scotch kinda guy (and man did that auction make me think it's time to take down stock allocations and increase hard liquor purchases), but yeah, that's a funny typo, and hey, whatever helps yo enjoy the weekend, no?

but kidding aside, i suspect that current fiscal woes at the state level are going to be a major catalyst for drug legalization. legalize it and tax it. many folks who might not have voted for it before will get on board if it keeps sales and property taxes from going up.

At 3/26/2010 3:55 PM, Blogger Methinks said...


Too true. I hope they do legalize it as I'm tired of funding an expensive, deadly and useless war on drugs.

Myself, I've never touched anything stronger than wine. But, what right do I have to dictate what other adults ingest?

Have a good weekend.

At 3/26/2010 4:08 PM, Blogger McKibbinUSA said...

Yes, the M2 growth rate is abating, which is exactly why we are teetering on the brink of deflation. My point is that should the economy fall into a deflationary spiral, no amount of fiscal and monetary expansion will reverse the collapse. Now is the time for expansionary measures, before it is too late...

At 3/26/2010 4:18 PM, Blogger Ron H. said...

Scott Grannis said...

See my related commentary on this subject, to the effect that a slowdown in M2 growth is not inconsistent with an increase in inflation.

Dr William J McKibbin said...

Yes, the M2 growth rate is abating, which is exactly why we are teetering on the brink of deflation.

Now THERE'S a difference of opinion.

At 3/26/2010 7:15 PM, Blogger Craig Howard said...

Yes, the M2 growth rate is abating, which is exactly why we are teetering on the brink of deflation.

Would that you were correct. Deflation is infinitely preferable to deflation -- the dollar's purchasing power increases.

At 3/26/2010 7:18 PM, Blogger PeakTrader said...

Scott, I don't see your correlation between the CPI and M2. It seems, inflation tends to accelerate in an expansion and monetary policy is accommodative in a recession.

Also, I wouldn't compare 1995 to today, because we may be heading into stagflation. Accelerating inflation can be caused by pent-up demand, foreigners absorbing fewer dollars, fewer goods, including imports, etc.

Moreover, the stock market is not the economy. People are likely to buy stocks, and anything else, rather than hold dollars when the value of the dollar is eroding:

Jim Rogers: S&P Could Go To 50,000 Jun. 3, 2009

It's a bear market rally. I was going to say I don't think S&P 500 will see new highs. But I have to quickly temper that by saying against the dollar because the S&P 500 could triple from here if they print enough money and the value of the US dollar collapses, then S&P could go to 50,000, Dow Jones can go to 1,000,000.

At 3/26/2010 7:29 PM, Blogger Benjamin Cole said...

Well, inflation or deflation?

In SoCal, commercial property is selling for one-half to sometimes one-quarter peak levels. Some smaller warehouses are holding up okay, but that's about it.

Should not a monetary inflation boom shoot property prices to the moon?

I sure hope so, but I don't see that happening for many years.

I think the Fed needs to pump even more money into the economy. I would fly a fleet of 747s and drop billions of Ben Franklins down on America.

We have created a Frankenstein financial system--we have our infrastructure, our factories, our subsidized farms, our human capital--but we can't make it function at full speed. It is stupid.

We should be working harder to pay off debts, not working less.

How do we get everyone working harder?

At 3/26/2010 7:42 PM, Blogger PeakTrader said...

Benjamin, yes, there's been too little money chasing too many assets and goods. Congress decided it's better to destroy excess assets and goods (by creating idle resources) rather than refunding U.S. households (e.g. a $5,000 per worker tax cut for 150 million workers or $750 billion).

Also, I may add, the excess capital is being destroyed, e.g. government spending $1 for something worth $0.50.

At 3/26/2010 10:15 PM, Blogger bobble said...

PeakTrader:". . . rather than refunding U.S. households (e.g. a $5,000 per worker tax cut for 150 million workers or $750 billion). "

it's not quite that bad. 37% of the stimulus is tax cuts ($288 billion)

At 3/27/2010 12:02 AM, Blogger Ron H. said...

>"Should not a monetary inflation boom shoot property prices to the moon?"

yes, an inflationary boom will shoot ALL prices to the moon. Why do you think that would be a good thing?

>"I think the Fed needs to pump even more money into the economy. I would fly a fleet of 747s and drop billions of Ben Franklins down on America."

That would be great! Then we would all have plenty of Ben Franklins. However, it might be sobering to discover that prices had all skyrocketed as a result, so that filling your gas tank cost $600/gal and a hamburger cost $350.00. Again, why do you think that would be a good thing?

Inflating the money supply doesn't make everybody better off.

>"How do we get everyone working harder?"

Everyone will work harder in their own self interest. Allow people to keep more of what they produce, remove barriers to innovation and stand out of the way. We ,will all be better off. Check with Adam Smith on this.

At 3/27/2010 12:25 AM, Blogger bobble said...

here's why you don't have to worry about inflation.

banks are not loaning that money out.

what you should be in fear of is deflation.

At 3/27/2010 2:19 AM, Blogger PeakTrader said...

Bobble, the American people aren't fooled. Taxes were raised on most people in the middle of the recession, by federal, state, and local governments, and much of the tax cuts are a year too late and targeted towards a small percentage of the population. Government cut and raised taxes at the same time. If you had a $5,000 tax cut, you'd know about it:

Poll Reveals Most Americans Don't Know They Got a Tax Cut
February 12, 2010

Here's the poll question: "In general, do you think the Obama Administration has increased taxes for most Americans, decreased taxes for most Americans or have they kept taxes the same for most Americans?"

The answer:
• 24 percent of respondents said they INCREASED taxes.
• 53 percent said they kept taxes the same
• And 12 percent said taxes were decreased.

Of people who support the grassroots, "Tea Party" movement, only 2 percent think taxes have been decreased, 46 percent say taxes are the same, and a whopping 44 percent say they believe taxes have gone up.

At 3/27/2010 2:41 AM, Blogger PeakTrader said...

U.S. inflation has already accelerated over the past year:

February U.S. and Canadian inflation rates stayed within an acceptable band
March 23, 2010

In the U.S., medical care services were +3.7% year over year and medical care commodities were +3.5%. The U.S. all-items index (+2.1%) is rising faster than the core rate (+1.3%). Energy (+14.4%) is contributing mightily to the increase in the U.S. all-items index. Year-over-year gasoline prices in the U.S. were +36.8%. New vehicle prices in the U.S. advanced at the same rate as in Canada +3.5%. Used car and truck prices, however, lurched forward by 14.1%.

Also, I may add, health care inflation may eventually rise like inflation in the used car market after Cash-for-Clunkers. When banks start lending again, and households pay-down more debt, inflation may accelerate.

At 3/27/2010 4:34 AM, Anonymous sprewell said...

Strictly speaking, neither inflation nor deflation matters that much, what matters are people's expectations of what that inflation will be. If people expect inflation to be 4% every year and write their contracts to take that into account, it will affect them even if it only drops to 1%. However, most people have no idea how inflation works and simply assume that if they're getting paid 3% more dollar bills this year, they'll be able to buy 3% more stuff. So to keep wages manageable and allow those ignorant employees to cling to their fantasy (what are usually called sticky prices/wages), the Fed follows a policy of targeting 3-4% inflation. The smart factor that into their dealings, the dumb don't. However, the Fed is only one variable in the equation and in times like today, private actors can override the Fed: banks by shrinking the private money supply and consumers by buying less stuff and damping velocity, counteracting the Fed's expansion of reserves of the public money supply, ie Fed notes.

At 3/27/2010 12:33 PM, Blogger Ron H. said...

>"However, most people have no idea how inflation works and simply assume that if they're getting paid 3% more dollar bills this year, they'll be able to buy 3% more stuff."

I'm not so sure. I think most people understand that things will cost them 3% more each year as well. What they may not give much thought to, is why this should be so.

Actually, we should expect many prices to DECREASE over time as competitors find ways to reduce production costs. Such price reductions are very visible for such things as computers and electronics.

What may NOT be so well understood, is that a Fed target of 3-4% inflation of the money supply allows government to spend the new money first, before prices have risen in response. This is a hidden tax that reduces the value of our dollars by the target rate of 3-4%.

An inflation rate of 4%, for example cuts the value of a dollar in half every 18 years. Put another way, things cost twice as much today as they did 18 years ago.

At 3/29/2010 6:00 PM, Anonymous PhilG said...

The thing that drove the market a few years ago, was the real estate market. As it stands today, there is little reason to believe that that market is ready to rebound. There is still tons of inventory to get rid of. Without any movement in that market, I tend to agree that inflation is still a few years away from rearing its ugly head.


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