Out of fashion
19 June 2018
Monetary aggregates used to be all the rage in the US. The Fed started collecting these data in the 1940s and set targets for the growth in money supply from the late 1970s. However, over recent decades these statistics have become less in vogue. From the late 1980s and into the 1990s, the relationship between both M1 and M2 growth and measures of economic activity such as GDP and consumer spending weakened (see Chart 2). In response, the Fed dropped its money growth targets in 2000 and even stopped collating M3 data in 2006. Given this backdrop, should we take much signal from the slowdown in these aggregates over recent quarters? Arguably not, especially since some of these indicators have likely become even more prone to distortions in the post-crisis period. The expansion in the Fed's balance sheet over the subsequent decade represented a radical increase in the monetary base, which more than quadrupled after 2008. With much of this increase reflecting a rise in central bank reserves, the distortions to some of the broader monetary aggregates have been much smaller (see Chart 3). However, M1 and M2 still grew by 14% and 8% respectively in the midst of the crisis in 2009, suggesting some effect on these measures.
Stepping away from the monetary statistics, we can look at trends in credit creation for signs of health. On this front there looks little cause for alarm. Commercial and industrial loan growth increased to 4.7% annualised over the past six months, suggesting upbeat business lending conditions. On the consumer side, both mortgage lending and consumer credit have been steady, at a respectable 2.4% and 4.9% annualised over the same period. Current growth, meanwhile, looks robust. Indeed, consumer spending seems to be rebounding nicely from a temporary Q1 blip, and a narrowing trade deficit suggests that net trade will provide a boost to growth in the second quarter. All in all, we see few reasons to believe that a slowdown is on the way.
One of the fears around quantitative easing (QE) when it was first instigated was that the enormous increase in the monetary base would be funnelled rapidly through the economy, creating rampant growth and inflation. This has clearly not been the case, reflecting in technical terms a decline in the velocity of money through the economy. However, then-Fed Chair Bernanke warned in 2009 that this expansion would need to go into reverse when credit markets and the economy began to recover. A decade on, the Fed is making progress. It continues to mechanically accelerate the roll off of assets purchased under QE, while using short interest rates as the primary tool for conducting monetary policy. On this front, last week the Fed hiked rates for a second time this year, as widely expected. The FOMC also updated its forecasts for the Fed funds rate, with the median estimate now for two more hikes over the course of 2018 and three more in 2019. Scratching beneath the surface, this was triggered by one member becoming more hawkish, rather than a landslide. However, the temperature on the committee over the past six months has clearly shifted towards earlier and more tightening. We expect this migration to continue as fiscal stimulus risks overheating the economy, and continue to look for two more hikes this year, four in 2019 and one in 2020.