Tuesday, March 24, 2009
The Fed's recent and extreme policies have made people nervous about inflation. They should be, but just not right now. Key central banks recently added hydrogen to their engines in the form of quantitative easing, causing high-powered money to surge. However, the multiplier is collapsing, and therefore, the new base is simply a measure to keep the money supply afloat. Some economies, though, are showing worrisome trends in their money growth rates.
The chart illustrates the 6-month annualized growth rate of the U.S. monetary base, commonly referred to as high-powered money. High-powered money is bank reserves plus currency, which does not cause inflation until it gets lent out to consumers and firms and turns into money. I like the 6-month growth rate because it captures more recent policy measures.
The chart illustrates the 6-month annualized growth rate of the broad measure of real money in the U.S., the U.K., Japan, and the Eurozone. In spite of the massive surge in the U.S. monetary base, 231% over the last 6 months, the real U.S. money supply grew just 22.6% over that same period. Can you imagine what would have happened had the Fed not eased so substantially? Troublesome deflation. The money multiplier is collapsing as banks hoard cash and consumers and firms pull back.
Furthermore, like the Fed, the Bank of England (BoE) is engaged in quantitative easing, resulting in a similar 6-month money growth rate, 22.8%. The ECB and the Bank of Japan (BoJ) are still increasing their broader measures of real money on a 6-month basis, but at a much slower rate. Admittedly, the BoJ is engaging in alternative policy measures, but the ECB and the BoJ are not pulling out all of the "easing stops" as are the Fed and the BoE.
This chart illustrates the monthly growth rate of the real measure of broad money for the same economies. The money supply data is current as of January 2009 for Japan and the Eurozone and February 2009 for the U.S. and the U.K. For now, the monthly real money supply growth rate remains above zero in the U.S., the U.K., and Japan. The European Central Bank (ECB) has let the money supply growth rate go negative; this is slightly worrisome if the trend continues.
This is a necessary policy action, given the alternative of allowing the money supply to collapse. However, John Taylor is worried, and frankly so am I. Because given the QE policies in place, the worst-case scenario or surging inflation, can only be avoided if the Fed gets its timing right. I tend to think that it will, but then again it might not.