Tuesday, July 6, 2010
I first articulated this theme in September 2008, and have returned to it many times since. My point is that the recession of 2008-2009 was not caused by a Federal Reserve tightening of monetary policy, the way it's been with every post-war recession. The recent recession was caused by a massive increase in the demand for money, which the Federal Reserve then struggled to accommodate. Since the Fed finally caught on and pumped up bank reserves by a cool trillion, the economy has been awash in money. Banks may be still somewhat reluctant to lend, but borrowers have also been reluctant to borrow, on balance, and many people seem to want to actually reduce their borrowing (i.e., by deleveraging).
This chart shows that it takes more and more money to accommodate a growing economy and ongoing (albeit fairly low these days) inflation. The red line shows the annualized growth rate of M2 on a rolling three-month basis, and the blue bars show the annualized growth rate of nominal GDP on a quarterly basis. On average and over time, M2 tends to grow by about the same amount as nominal GDP. Over the most recent 3-mo. period ending June 21st, M2 grew at a 4.1% pace and shows signs of accelerating. I'm guessing we'll see nominal GDP growth of at least 3-4% in the second quarter, and if so that would be a sign that M2 velocity (GDP/M2) is roughly stable. I actually think that velocity is likely to increase a bit—it's been rising at a decent pace since last summer—and if so, then we could see nominal GDP come in at an even higher rate.
The dollar has weakened of late, and the growth of currency in circulation (a good proxy for he world's demand for dollars) has slowed down in the past few months, and those are both good signs that M2 velocity is rising (velocity being the inverse of money demand). So with M2 rising and M2 velocity likely rising as well, there is good reason to believe that we will be seeing healthy rates of GDP growth. Again, no sign here of any slowdown or imminent recession.
Posted by Scott Grannis at 11:53 AM