Pushing On a String
As John Taylor recently noted, M2 money growth has spiked in the last few weeks. This seems to be due to the deposit component of M1, probably because of depositors fleeing into the relative security of American banks in the face of the ongoing European crisis.
Despite the massive growth in the monetary base, we have seen very little corresponding growth in broader measures of the money supply and hence little threat of inflation. But could this be changing? That depends in part on what happens to the money multiplier, which has been in the doldrums since the financial crisis. The multiplier effect has simply been absent for a couple of years – not surprising since the Fed has been paying banks interest on their excess reserves (see the article here).
The St. Louis Fed reports the M1 money multiplier on a bi-weekly basis, so we can take a look at what has recently been going on and the potential of inflationary pressure. Here it is since the beginning of 2010.
The money multiplier has increased sharply over the past few weeks but remains well below 1 (for a multiplier of 0.8, every $1 increase in the monetary base increases the money supply by only $0.80).
For a bit more perspective, here it is since the beginning of 2007:
The collapse in the multiplier from around 1.6 to less than 1.0 is mainly the result of an enormous increase in excess reserves (see the chart below and the article here). The recent uptick, put into some historical perspective, is not too thrilling unless there are reasons to believe it will be a sustained increase and there are not strong indications that will be the case.
As Paul Samuelson wrote long ago, the Federal Reserve banks “can encourage but, without taking drastic action, they cannot compel. For in the middle of a deep depression just when we want Reserve policy to be most effective, the Member Banks are likely to be timid about buying new investments or making loans. If the Reserve authorities buy government bonds in the open market and thereby swell bank reserves, the banks will not put these funds to work but will simply hold reserves.”
So, even had Bernanke announced QE3 in Jackson Hole last week, it is not entirely clear that it would have done much. Dramatic Fed action still has the potential to work, but I have my doubts. Perhaps possible success is enough to justify the effort, but we should be realistic about the likelihood of success.