Money supply

 

The federal reserve has discontinued

publishing their m1 and m2 money stock

series here to discuss the implications

and what

this means and why they've done this is

an expert on monetary policy

steve henke professor of applied

economics at johns hopkins

university professor henke welcome backlet's talk about this

why has the federal reserve discontinued

these series they've been publishing

this since

the 70s you told me offline

yes they've been publishing various

monetary statistics and statistical

series since 1971 so-called m1 m2

m3 and so forth but they've changed thedefinitions and the frequency with which

they

report them and and they've discontinued

Some series

i think that before we get started uh

david let me remind you of president

bill clinton's maxim he

he had a maxim that was it's the

economy

stupidand my maxim it's the money supply

stupid

and the reason for that is that the

money supply

determines the course of nominal gdp

and nominal gdp includes real

growth and the inflation rate that's

what makes up nominal gdp

so if we go back let's kind of get thestory before we get into the weeds on

on the technical statistical series and

and and to set the stage is really what

people have to get in mind

measuring money and the money supply

became

very important in the united states when

paul volcker

became chairman of the federal reservein 1979 and shortly atter he became

chairman

he said that we are going to start

watching the money supply

it is the money supply stupid and the

reason for that

is that the inflation rate in the united

states

when volcker entered the scene was 13.3

percentlow double digit inflation it was it was

stagflation in those years

and so he slowed the money supply

down measured by m2 that that

particular

version which actually has nine

Components in it

uh starting with currency and and

uh then demand deposits and savings

deposits and so forth and so on but m2he was using as as his measure

he cranked it down to seven percent put

a squeeze on

and by 1982 the inflation rate in the

united states

had been squeezed down to 3.8 percent

but there was a problem and and that is

we experienced twO recessions one in

1980which was very mild and then a fairly

severe one in 1982

So the squeeze that he put on

got inflation down but it squeezed a lot

of real gdp out of the system now the

reason for that

was due to the money supply

measurements

volcker had the thing right it was the

money supply he had to focus on themoney supply

he had to slow it down but he thought

by looking at the fed's measures of m2

that he he was slowing it down to around

seven percent per annum growth

in fact if you measured

the money supply growth properly

money supply was actually contracting it

wasit was going negative on him but he

didn't know that

So the key thing is you have to measure

the money supply correctly you've got to

get

the the the correct measure on your

dashboard

or you've got a big problem okay so it

is the money supplythat's very important and and when i say

the money supply measured properly

actually went negative what doi mean

what was going on

there's something called the division

measure of money supply

and and it happens that the world's

expert on this is

bill barnett professor at the universityof kansas and

fellow at the center for financial

stability in new york where

division measures of the money supply

are actually

published now what is division well

if you look at the normal measure

of the money supply whether it's m1 orof the money supply whether it's m1 or

m2

it's those are called simple sum

indices in other words you have various

components i said there were nine

components in m2 and and you just add

those nine components up and that's a

simple sum and that gives you the total

m2 now davisia does things differentlydavisius says yeah there are nine

components in m2

but each one of those has a different

degree of

moneyness in it in other words currency

gets a hundred percent weight because it

it it you can use it immediately for a

transaction

a checking account is also an m2 andthat that gets

also a 100 weight but other things that

are in the

components the other components get

less

than 100 percent

weight and that weight changes around

depending primarily on the interest rate

let's say the interest rate

in volcker's time on uh savings accountsdouble digits well in that case

the opportunity cost of you exchanging

your savings account or your money

market account or

whatever the component happened to be

in

the money supply that you were

measuring

you'd be very reluctant at those high

interest rates to actuallyis money and can be used directly in

transactions

So as a result of those high interest

rates

the division measure of m2 actually went

negative in the in the early 80s and

and that would have been the proper

measure that would have been the right

thing to have on your dashboardunfortunately the fed wasn't producing

it and volcker didn't have it so

volcker thought he he was not squeezing

it

excessively he thought he was right on a

money

at squeezing things down to about seven

percent

m2 growth with his simple some fed

numberbut the real number was negative and

that's why we had these two recessions

yeah i wan i want to ask you about uh

what you said earlier

on on the priorities of the federal

reserve so before

volcker realize money supply was

important as a tool for measurement but

now you're saying that the federal