Monday, October 5, 2009
M2, arguably the best measure of the broad money supply, has not grown at all since early March. As this chart shows, the 6-mo. annualized rate of growth of M2 is now negative, after being hugely positive early this year. Is this a cause for concern? Hardly. In fact, I think this is a very bullish development.
We see a similar pattern in 2003: strong growth in 2002 and early in 2003, followed by a sharp slowdown in money growth. The main driver of big changes in M2 growth is money demand. Money demand was strong in 2002 and early 2003, and it was strong late last year as well, because of the combination of a) fears of extended economic weakness, and b) very accommodative monetary policy. Faced with uncertainty, people attempted to build up their money balances, and the Fed was willing to accommodate that. When uncertainty subsided in mid-2003 (helped to a significant degree by cuts in marginal tax rates) then money demand fell; money that had been stored up to guard against uncertainty was released into the economy, fueling a strong rebound in economic activity. I think the same thing is happening now. Uncertainty is falling, and money demand is falling, and the economy is expanding once again.
So very low or even negative growth in M2 is actually a positive sign: confidence is returning and money that was accumulated as a hedge is now being released into the economy to fuel growth.
Posted by Scott Grannis at 8:08 AM