Thursday, April 25, 2024

M2 still points to lower inflation

The Fed recently released the March money supply numbers, and the story hasn't changed. M2 surged from early 2020 through early 2022, thanks to $6 trillion of deficit spending that was effectively monetized. Since its peak in April '22, M2 has declined by almost $1 trillion. This all adds up to the biggest seesaw in U.S. monetary history. As the dust continues to settle we see that a lot of the excess growth in M2 has been absorbed by a bigger economy and suppressed by higher interest rates, which have boosted the public's willingness to hold onto the extra money. The question now is not whether inflation will rise, but rather how much further it will decline. 

Chart #1

Chart #1 shows the history of M2 growth (plotted on a logarithmic y-axis so as to show constant rates of growth as straight lines). The huge bulge in M2 which began in Q2/20 was fueled by about $6 trillion in Covid "stimulus" checks which were effectively monetized (not borrowed, but printed) and largely sat in people's checking accounts for almost two years. (Prior to this, deficit spending by Treasury was routinely financed by selling bonds, which created no new money as a result.) The "bulge" in M2 rose to a high of $4.7 trillion in Dec. '21, and has now fallen by almost two thirds. This was the result of negative growth in M2 and ongoing growth in the economy. 

Chart #2

Chart #2 shows the growth of currency in circulation. This is a fairly good measure of money demand, since no one holds onto currency without a reason to do so. Excess, or unwanted currency is easily returned to the banking system in exchange for interest-bearing deposits. This chart demonstrates the significant increase in money demand from 2020 through late 2021, a time when uncertainties were running rampant and it was difficult to spend money. Since early 2022 money demand by this measure has returned to "normal." Rising money demand kept the bulge in M2 from being inflationary, while declining money demand coincided with an increase in inflation. In short, for the past two years the increase in inflation that has proved so distressing was simply the result of unwanted money being spent: too much money chasing too few goods. Money demand has apparently returned to more normal levels now, so, with a lag, inflation is likely going to continue to decline.

Chart #3

Chart #3 is my definition of money demand: M2 divided by nominal GDP. This is best thought of as the percentage of total income (GDP) that the public chooses to hold in the form of readily spendable cash (M2). Here we see that money demand—after surging in the wake of the Covid panic—is rapidly returning to what might be termed normal. 

Chart #4

Chart #4 compares the year over year growth of M2 with the year over year change in the CPI, which has been shifted to the left by one year to suggest that there is a one-year lag between changes in M2 and changes in inflation. The red asterisk at the Mar. '24 mark is the rate of CPI inflation ex-shelter (see this post for a more detailed explanation). It would appear that the lag has lengthened a bit to perhaps a year and a half. That further suggests that given the decline in M2 we are likely to see further declines in inflation over the balance of this year. 


F said...

Hi Scott, I’m curious - do you have an M2 chart going back to the 1970s?

Wondering if M2 also caused the 1970s inflation (and if not; why)?

Tom said...

I love your definition of money demand: M2 divided by nominal GDP. It's simple and easy to understand. Question - the rapid advance after 2010 - is that coincident with or caused by the Fed's shift to an abundant reserve model? Or is it the same thing?

CaffersXL said...

You can check the M2 data using the FRED data series. The CAGR for the 1970s (Jan 70-Dec 79) is 9.6%.

1980s is 7.9%.

1960s is 7%.

1990s is 3.89%

2000s is 6.2% but skewed by the QE from 2008-

2010s is 6.1% with QE in the mix.

90s stand out as a good decade, wonder why.

Duane Stiller said...

Scott, Do the Fed’s high short term interest rates create inflation pressure by causing the banks to pay higher than inflation interest on deposits? M2 looks pretty big and assuming that depositors are earning CPI+2% seems to increase cash available to spend,

Salmo Trutta said...

I don't know if there's a good correlation between M2 and inflation. But based on theory, there's not. It goes back to George Garvey:

Deposit Velocity and Its Significance (

“Obviously, velocity of total deposits, including time deposits, is considerably lower than that computed for demand deposits alone. The precise difference between the two sets of ratios would depend on the relative share of time deposits in the total as well as on the respective turnover rates of the two types of deposits.”

That's how you get Friedman's "long and variable lags".

No, monetary lags are mathematical constants, other things equal.

Scott Grannis' M2 ignores the fact that retail MMMFs are nonbanks.

Scott Grannis said...

Re "Do the Fed’s high short term interest rates create inflation pressure?"

Interest payments typically are not made with newly-minted money, so they do not expand the money supply nor are they inflationary.

Scott Grannis said...

tom, re rising money demand post-2010. Rising demand for money beginning in 2010 was very likely symptomatic of declining tolerance for risk, which in turn was sparked by the Great Recession of 2008-9. Simply put, the public sought the safety of cash. This also explains why the Fed was able to keep interest rates unusually low during that period.

Henry H said...

Feds maintain current rate. Powell ruled out a potential hike.

Roy said...

So is QE de facto back?

Ai said...

Why the Fed should already be cutting

Ai said...

This is absolutely priceless. And probably the most frightening clip you'll ever watch on the people in charge of the US economy.

Jared Bernstein is literally the Chair of the Council of Economic Advisers, the main agency advising Biden on economic policy

wkevinw said...

Jared Bernstein's educational background from Wikipedia (hint- he is not an economist by training-a lot of these people are hired for PR skills- or something like that)

"Bernstein graduated with a bachelor's degree in music from the Manhattan School of Music where he studied double bass with Orin O'Brien. Throughout the Eighties Jared was a mainstay on the jazz scene in NYC.[citation needed]

He also earned a Master of Social Work from Hunter College as well as a DSW in social welfare from Columbia University's school of social work"

Salmo Trutta said...

There's no single figure compiled which represents the value of money. Instead, there are many specialized types of indexes.

And applying a y-o-y rate-of-change doesn't reflex the proper change in any index.

wkevinw said...

It's hard to have a recession without bad employment stats, one of which is continuing claims. This is an adjusted figure, and I am not sure what is in the adjustment. The series trended up in mid-2023. However, it has since plateaued and remains at a significantly lower level than where past recessions started; yet another set of data with unusual behavior following the 2020 economic gyrations.

Roy said...


I hope you are well. Could you update us with your thoughts?