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Slow M2 growth not necessarily bad




From today's money supply data, we see that M2 has grown only 0.9% in the past year. Since 1960 at least, M2 growth was only lower than this in late 1994 and early 1995. Is this a cause for concern, or a portent of deflation? Not necessarily. Recall that in early 1995, almost at precisely the same time that M2 growth approached zero, the stock market began a powerful rally that lasted through early 2000.

As I've discussed several times before, slow money growth that comes on the heels of unusually fast money growth typically reflects a decline in the demand for money, not a tightening of monetary policy. This decline in money demand goes hand in hand with a recovery in confidence and with a recovering economy. People tend to accumulate money balances when uncertainty is high, then spend the money as uncertainty is gradually replaced by confidence and eventually optimism. I think this is one of those times.

So rather than fear slow money growth, we should welcome it as a sign that people are again deciding to put their money to work, rather than hoarding it. By spending their M2 balances, the public is helping to get the economy back on its feet, and at the same time minimizing the risk of deflation.

UPDATE: Mark Perry and I have been having a friendly back-and-forth over the issue of whether my call for rising inflation is consistent with the pronounced slowdown in M2 growth shown in the above chart. As partial support for my view, I submit the following chart, which simply compares M2 growth and growth in the consumer price index. I would note that the two lines display a substantial degree of negative correlation, which is to say that inflation has a tendency to rise as money growth declines, and vice versa. I think this is consistent with what I have described above, namely, that changes in M2 growth reflect changes in money demand, and this can have important implications for economic growth and inflation. You can see his latest commentary on M2 growth here.


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