Monday, March 5, 2012

Fed's Interest Rate Policy Distorts Money Stock Growth

The low interest rate policy of the Federal Reserve continues to distort the growth rates of the money stock. 

The year-over-year rate of growth for the M1 money stock for the thirteen-week period ending February 21, 2012 is 18.6 percent.  Note, however, that the year-over-year growth rate for the demand deposit component of the M1 money stock is just over 44 percent!

Because of the low interest rates on bank time and savings deposits and on retail money funds and on institutional money funds, people continue to move money from these assets to transaction accounts, primarily demand deposits.  However, people seem to be holding onto these transaction balances rather than spending them. 

The M2 measure of the money stock is rising by a 9.8 percent year-over-year rate of increase, but the non-M1 component of the money stock is rising by only 7.6 percent.  Again, the primary growth in this component is coming from the movement of money from non-bank interest-bearing assets to bank deposits. 

People are still not moving their assets around in order to increase spending. As just mentioned, a lot of the movement is coming because the incentive to hold interest bearing non-bank assets is not there.  And, individuals and families that are under-employed or otherwise uncertain about their future are transferring their assets into cash.  Currency in circulation is still increasing, year-over-year by a little less than 10 percent, an extraordinary high rate of growth.

The Fed has done very little to further stimulate the domestic economy over the past three months.  Looking at the Fed’s balance sheet, there are two factors that are particularly noticeable, neither one, however, representing any kind of an aggressive monetary injection. 

First, the Federal Reserve has responded to the European debt crisis by providing additional funds to central banks through swap lines.   Over the past three months, central bank liquidity swaps have increased by $105 billion.  This increase in funds represents almost the whole rise in reserve balances at the Fed, a figure that tracks very closely with the amount of excess reserves in the banking system. 

Second, the Fed has attempted to push the interest rates on mortgages even lower in an attempt to get the housing sector going again.  Whereas the Fed has allowed its portfolio of US Treasury securities to decline along with a continued decline in its holding of Federal Agency issues, the central bank has actually added a net of almost $14 billion to its holdings of mortgage-backed securities over the past thirteen week period.  The total amount of securities held outright declined by about $2 billion.

Consistent with the monetary testimony of Fed Chairman Ben Bernanke last week, the Federal Reserve has been doing very little to provide additional stimulus to the American economy. ( People continue to move funds from low interest bearing market assets to the banks.  Mr. Bernanke and the Fed apparently hope that these individuals will at some time in the future begin to spend more from these assets.  Banks continue to hold onto their funds as excess reserves in the banking system track around $1.6 billion.  Most banks, especially the smaller banks, are not lending as they continue to work out the problems that exist in their loan portfolios.  According to Mr. Bernanke, this situation will continue to be supported by the Federal Reserve for the near term.

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