Money supply growth can often be a helpful measure of economic activity. During periods of economic boom, money supply tends to grow quickly as banks make more loans. Recessions, on the other hand, tend to be preceded by periods of slowdown in rates of money supply growth. However, money supply growth tends to grow out of its low-growth trough well before the onset of a recession.
Fuelled by unprecedented quantitative easing, central bank asset purchases, and various stimulus packages, the money supply growth rate spiked in April, to an all-time high. The growth rate touched highs, with the 1970s being the only period that saw similar close levels. As expected, money supply growth would surge, given the circumstances, but the magnitude of growth, might not have been aligned to initial expectations.
During April 2020, year-over-year growth in the US’s True Money Supply was at 21.3 per cent. That's up from March's rate of 11.3 per cent, and up from April 2019's rate of 1.94 per cent. Historically, this is a very large surge in growth both month over month and year over year. It is also quite a reversal from the trend that only just ended in August of last year, when growth rates were nearly bottoming at around two per cent. In August, the growth rate hit a 120-month low, falling to the lowest growth rate markets had seen since 2007.
Although some observers will likely claim that the current economic crisis is a result solely of the COVID-19 panic and resulting government-forced shutdowns, over the past months several indicators suggested that the economy might have been signalling some form of weakness. Clearly, in an action to combat the extraordinary event of COVID-19, the Fed's moves to drop interest rates and to once again grow its balance sheet is crucial at this point in time.
Undoubtedly, the growth in the money supply in recent months is in part tied to the fact that the Federal Reserve grew more accommodative in late 2019 and embraced unprecedented monetary stimulus in March and April. The Fed drove down the target key interest rate to 0.25 per cent and began broad new quantitative easing programs.
Indeed, the Fed cut the target Fed Funds rate more than once in the months preceding March 2020, in response to government-forced shutdowns of several sectors of the economy, while a cut of 150 basis points took place in less than a month. Furthermore, the Fed has flooded markets with new money by purchasing a variety of assets from US government debt to securities. Thus, the Fed's balance sheet is now at an all-time high.
Another change partially driving the increase in the US’s True Money Supply is the large increase in Treasury deposits that markets have seen in recent months. In April 2020, this sum surged to a new all-time high of $783 billion. This is well in excess of the previous high of $423 billion reached during February of this year.
Usually, an increase in money supply should lower interest rates in the economy and hence, justifies the reason for the Fed’s rate cut. An increase in money supply means that more money is available for borrowing in the economy which would likely lead to rates of consumption, lending and borrowing to go up. In the short run, higher rates of consumption, lending and borrowing can be correlated with an increase in the total output of an economy and spending and, seemingly, a country's GDP.
Another positive note is that although under normal circumstances, a spike in money supply would increase concerns over inflation, the Atlanta Fed’s May and 10 year CPI expectations have remained unchanged. Given current events, supply is more likely to recover faster than demand and hence, would keep inflation pressures under control.
Conclusively, it is more than evident that although money supply has spiked significantly, the Fed has taken an utmost accommodative approach to turn around negative economic data with the hope of a fast recovery for the US economy. The collateral damage of all this liquidity is yet a future unknown. Undeniably, at this juncture the unprecedented circumstances gave no option to central banks in increasing the money supply, in addition to other easing actions to combat the remarkable economic impact.
Disclaimer: This article was issued by Maria Fenech, credit analyst at Calamatta Cuschieri. For more information visit www.cc.com.mt. The information, view and opinions provided in this article are being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice.