A Heretic On The FOMC?

By: Paul Kasriel | Thu, Sep 1, 2005
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I almost fell out of my chair when reading the minutes of the August 9 FOMC meeting. What rocked me? The following sentence: "Another participant mentioned, however, that recent sluggish growth of the monetary aggregates suggested that the stance of policy was not overly accommodative." Can you believe that someone on the FOMC actually has put "M" back in monetary policy? What's more, even a Fed Board staffer made a telling comment about the behavior of the monetary aggregates. To wit: "Despite the recent slow growth of M2, its velocity remained low relative to the level that would be expected based on its historical relationship with opportunity cost." So, not only has M2 growth been slow, but faster velocity growth is not compensating for it.

The chart below shows the history of the year-over-year percent change in the real M2 money supply (nominal M2 divided by the CPI). As of July 2005, real M2 was up only 0.6% vs. year ago. The nadir of real M2 growth prior to the 2001 recession was 2.0% in July 2000. Real M2 growth in July 2005 was below what it was just prior to the 1960 recession and the unofficial "mini" recession of 1967. Although real M2 growth currently is above what it was in the recovery following the 1990 recession, money velocity growth was much stronger at that time. Although real M2 is not as reliable a leading indicator as it used to be, it still is reliable enough to be included as a component of the Conference Board's Leading Economic Indicators index. And its trend growth behavior still provides good qualitative information about the trend growth in economic activity. Real M2 growth currently is sending a warning signal about the future trend growth of real economic activity. At least one FOMC member has taken notice. I would not be surprised if the tone of discussion at the September 20 FOMC meeting is somewhat more guarded about the strength of the economy going forward. That is, the comment that monetary policy remains accommodative may be on the way out.


Paul Kasriel

Author: Paul Kasriel

Paul L. Kasriel
Director of Economic Research
The Northern Trust Company
Economic Research Department
Positive Economic Commentary
"The economics of what is, rather than what you might like it to be."
50 South LaSalle Street, Chicago, Illinois 60675

Paul Kasriel

Paul joined the economic research unit of The Northern Trust Company in 1986 as Vice President and Economist, being named Senior Vice President and Director of Economic Research in 2000. His economic and interest rate forecasts are used both internally and by clients. The accuracy of the Economic Research Department's forecasts has consistently been highly-ranked in the Blue Chip survey of about 50 forecasters over the years. To that point, Paul received the prestigious 2006 Lawrence R. Klein Award for having the most accurate economic forecast among the Blue Chip survey participants for the years 2002 through 2005. The accuracy of Paul's 2008 economic forecast was ranked in the top five of The Wall Street Journal survey panel of economists. In January 2009, The Wall Street Journal and Forbes cited Paul as one of the few who identified early on the formation of the housing bubble and foresaw the economic and financial market havoc that would ensue after the bubble inevitably burst. Through written commentaries containing his straightforward and often nonconsensus analysis of economic and financial market issues, Paul has developed a loyal following in the financial community. The Northern's economic website was listed as one of the top ten most interesting by The Wall Street Journal. Paul is the co-author of a book entitled Seven Indicators That Move Markets.

Paul began his career as a research economist at the Federal Reserve Bank of Chicago. He has taught courses in finance at the DePaul University Kellstadt Graduate School of Business and at the Northwestern University Kellogg Graduate School of Management. Paul serves on the Economic Advisory Committee of the American Bankers Association.

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