Monetary Definitions
M1: M1 consists of (1) currency outside the U.S. Treasury, Federal Reserve Banks, and the vaults of depository institutions; (2) demand deposits at commercial banks (excluding those amounts held by depository institutions, the U.S. government, and foreign banks and official institutions) less cash items in the process of collection and Federal Reserve float; and (3) other liquid deposits, consisting of OCDs and savings deposits (including money market deposit accounts) – Revised May 2020
M2: M2 consists of M1 plus (1) small-denomination time deposits (time deposits in amounts of less than $100,000) less IRA and Keogh balances at depository institutions; and (2) balances in retail MMFs less IRA and Keogh balances at MMFs. – Revised May 2020
Base Money: The monetary base is the sum of currency in circulation and reserve balances (deposits held by banks and other depository institutions in their accounts at the Federal Reserve).
What Is Inflation?
If inflation is an increase in money supply, then which money supply?
Money Supply Measures Percent Change
Money Supply Measures Percent Change Detail
If you believe an increase in M1 is the measure of an increase in inflation, then year-over-year inflation hit 357% in February of 2021.
Let’s exclude M1 and see what we get.
M2 and Base Money Percent Change
If inflation is measured by Base Money then most of 2015-2020 was a period of deflation before soaring to 58.71% in May of 2020.
If inflation is measured by M2, the year-over-year increase was 1.61% in 2010, then hovered between 3% and 6% for lengthy period before surging to 27.1% in February of 2021.
M2 Money Supply vs the CPI
The above chart suggests there is no relationship at all between consumer prices and money supply.
But if money supply itself is the measure of inflation, there there will only be a sustained explosion in inflation if there is a sustained explosion in money supply. The past explosion being irrelevant.
Will the Fed Balance Sheet Get Spent into Circulation Causing Inflation?
The Fed’s Balance Sheet is Not Spendable Money
For discussion, please see Will the Fed Balance Sheet Get Spent into Circulation Causing Inflation?
QE does foster bubbles as part of the psychological impact and by interest rate suppression, but it does not represent spendable money nor does it constitute inflation in and of itself. Thus Schiff’s Tweet is economic silliness.
Subtracting QE
If QE is essentially meaningless from a monetary standpoint (and it is) then we should subtract QE from monetary measures.
Money Supply Measures in Billions of Dollars
I also subtracted QE from M1 but the numbers were on occasion deeply negative.
I am not sure if this was a result of a recent change in the definition of M1, sweeps in which money in demand deposits (checking accounts) really isn’t there, or another M1 distortion of some kind.
M2 and M2 Minus the Fed’s Balance Sheet Percent Change
The above chart explains the sudden and sustained housing collapse, the Taper Tantrum, and the weakness that predated the pandemic.
Money Supply as a Measure of Inflation
If someone tells you inflation is about money, be prepared to fire back some questions.
- What is your measure of money supply?
- Is it M1, M2, M3, MZM, or what, and why?
- Are you subtracting QE from your analysis, why or why not?
Difficult Subjects
For years I regarded inflation as “an increase money supply and credit marked to market”. I used Austrian Money Supply as a measure and that is nearly the same as M2.
However, the Fed suspended mark-to-market rules in 2009 and never reinstated proper accounting. Even prior to the rule change, mark-market accounting was really mark-to-fantasy.
Measurement by my definition was impossible and it missed subtracting QE.
In contrast, M2 minus the Fed’s balance sheet explains much and is measurable but it misses proper loan accounting. Are the loans on the balance sheets of banks any good or not?
Milton Friedman’s statement “Inflation is always and everywhere a monetary phenomenon,” is catchy. But it sheds little light on anything especially when people confuse QE with actual spendable money.
Whatever your measure of money, it should not include QE but that does not mean QE is harmless.
QE sponsors bubbles and central banks are addicted to it. For discussion, please see The House of Lords is Concerned Over a Dangerous Addiction to QE.
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