Growth in Real Money Supply is What is Important for Taming Inflation, and for the Fed
Two weeks ago, we wrote (see our March 10, 2023 Weekly Economics) that a reduction in money supply should not be considered out of the ordinary and showed that while growth in the nominal supply of money recorded its first negative reading since 1960 on a year earlier basis, real money supply growth has been negative during long periods of time during the last 63 years. In fact, as is the case with variables in an economy, what is important is not its nominal value but its real value.
This is also true for the supply of money. What we should be looking at is the growth rate in the real money supply, not the nominal money supply. But we also said in that weekly publication that the expansion in the money supply, both real as well as nominal, wasn’t a ‘normal’ monetary cycle. In fact, it was no monetary cycle at all because a monetary cycle would mean strong growth of lending. But this is not what happened. What happened was a very large transfer from the U.S. government to Americans, individuals as well as firms, of direct payments in terms of checks, extra unemployment insurance, as well as PPP loans that ended up being gifts to firms.
Normally, the U.S. Federal Reserve (Fed) reduces money supply by increasing interest rates and this reduces the growth rate of loans. However, this time around, since banks did not lend that much coming into this latest tightening cycle, there is very little that the Fed could tighten today. The only exception is, as we mentioned in that weekly publication, credit card lending.