Effective money, our favored broad money aggregate for the US, is the sum of plain old bank money – M2 or savings and checking deposits – and shadow money, which is based on the outstanding value of liquid debt securities which can be repo’d quickly for cash. (The thought is if a $100 security is so liquid that you can borrow, say, $95 in cash by posting the security as collateral, then owning the security will affect your behavior just like owning $95 in cash.)Because effective money is influenced by monetary policy, fiscal policy, bank balance sheet expansion, and shadow bank credit expansions (e.g. ABS funding of auto loans), our aggregate is broad enough to tell us something useful about the economy and the possible direction of inflation.Effective money was $27.7 trillion in February 2007 and collapsed to $25.7 trillion by late 2008. Much of the fall was in private shadow money, which suffered from a collapse of funding liquidity (rising haircuts), a sharp fall in bond prices, and very weak net issuance. However, this deflationary shock was offset by a public balance sheet expansion. Later in the recovery private shadow money rebounded, and our latest estimate of effective money is now $33.8 trillion
, parts of the expansion – especially on the monetary side – are easily reversible with central bank balance sheet and interest operations including the payment of interest on reserves, which could cull any sharp increase in bank credit expansion.Fourth, although credit expansion has begun to revive in certain places, there really is no sign yet of runaway demand growth in the US. And unemployment and the output gap remain very high.But of all these reasons, the one we would urge monetarists and inflation worriers to ponder most is the first....
So far at least, we suspect that there has been nowhere near enough money printing to raise the risk, let alone guarantee, runaway inflation.
As far as Japan is concerned, the situation is very clear. And it’s a good example. I’m glad you brought it up, because it shows how unreliable interest rates can be as an indicator of appropriate monetary policy.
During the 1970s, you had the bubble period. Monetary growth was very high. There was a so-called speculative bubble in the stock market. In 1989, the Bank of Japan stepped on the brakes very hard and brought money supply down to negative rates for a while. The stock market broke. The economy went into a recession, and it’s been in a state of quasi recession ever since. Monetary growth has been too low. Now, the Bank of Japan’s argument is, “Oh well, we’ve got the interest rate down to zero; what more can we do?”
It’s very simple. They can buy long-term government securities, and they can keep buying them and providing high-powered money until the high powered money starts getting the economy in an expansion. What Japan needs is a more expansive domestic monetary policy.
The Japanese bank has supposedly had, until very recently, a zero interest rate policy. Yet that zero interest rate policy was evidence of an extremely tight monetary policy. Essentially, you had deflation. The real interest rate was positive; it was not negative. What you needed in Japan was more liquidity.(why? because velocity did not increase)