The Case for the Federal Reserve to Pause Right Now

If you believe in the Milton Friedman adage that inflation is always and everywhere a monetary phenomenon, then you should also believe that the Federal Reserve can stop increasing interest rates. Now.

Raising its target rate rapidly from near zero early last year to 4.50% in December made sense not just with core inflation surging above 6%, but also with the money supply measured by M2 soaring by almost $6 trillion, or some 41%, as the government flooded the economy with cash to support consumers and businesses during the pandemic.

But while inflation has come down slowly, growth in the money supply has quickly decelerated, contracting on a year-over-year basis for the first time since at least 1960, according to Fed data compiled by Bloomberg. Perhaps more important, a broader measure of M2 that tracks checking accounts, saving accounts, money market accounts and short-term certificates of deposit as well as other liquid deposits has already turned negative on a year-over-year basis, tumbling $1.35 trillion from the peak in March to $12.4 trillion in December, a drop of 9.8% In other words, the money supply is shrinking.

The Fed’s rate increases, which came at a pace not seen since the days of Paul Volcker in the early 1980s, have had a hand in reducing the money supply and the excess savings that consumers accumulated during the pandemic. In essence, consumers have had to tap into their savings to cover higher interest payments on everything from mortgages to auto loans and credit card balances — or to avoid them by paying cash for bigger-ticket goods. The real estate market is a prime example. Some 30% of homes purchased in December were bought with cash, the highest percentage in eight years, according to property research firm Redfin.