I’ve never been a big fan of the Fed’s balance-sheet-ballooning operations. But I have acknowledged in several columns and on the air that I was completely wrong two years ago when I said the Fed’s money-creating program would lead to higher inflation. In fact, the Fed’s favorite inflation indicator — the personal consumption deflator — is rising only 1 percent year on year. On top of that, bond-market indicators of future inflation are falling. Plus, the gold crash. You can almost make a case that the Fed is too tight, not loose. Deflation is in the air.
While the Fed’s balance sheet was exploding, bank reserves were not circulating through the economy. So the M2 money supply has been growing around 7 percent, in line with its long-term trend. Meanwhile, the lack of cash circulation has pulled velocity down by about 3 percent. So nominal GDP is growing around 4 percent, which is at least 1 to 2 percent too low in total spending for a real recession recovery.
Bernanke jumped the gun this week, and markets are in revolt. They’re trying desperately to tell the Fed chair to go slow, not fast — perhaps even to wait for pro-growth tax reform and additional budget restraint out of Washington. As clumsy as the QE process may be, it still looks like the economy requires more money creation. Big Ben made a mistake. The training wheels need to come off slowly.
St. Louis Fed president James Bullard, an FOMC dissenter, seems to agree. As a statement from the regional Fed bank today puts it: “President Bullard felt that a more prudent approach would be to wait for more tangible signs that the economy was strengthening and that inflation was on a path to return toward target before making such an announcement.”
And let me add to something to Mr. Kudlow’s analysis. Another way to look at money supply is through a broader aggregate from the Center for Financial Stability called Divisia M4, which includes negotiable money-market securities, such as commercial paper, negotiable CDs, and T-bills. This measure, despite the Fed’s balance sheet expansion, is barely higher than it was in back in autumn 2008. “This is a monetary famine, not a feast,” wrote Martin Wolf the other day.