The title above is also the title of an opinion piece by Allan Meltzer in the May 7, 2014, print edition of the Wall Street Journal. Let me say that I am an acquaintance and long-time admirer of Alan Meltzer. He is the world’s foremost historian of the Federal Reserve. Also relevant, he is a long-time “monetarist” and co-founder of the Shadow Open Market Committee, formed to critique Fed monetary policy.
While I agree with some of Meltzer’s points and disagree with others, the most frustrating thing about his piece was the title “How the Fed Fuels the Coming Inflation.” I know from experience that authors have little say in the titles the WSJ puts on their contributions; so he might not be committed to it. But he has more clout in such matters than I ever would; so he may be complicit.
One thing wrong with the title is that it is open ended. Meltzer and many others have been saying the same thing for several years and inflation hasn’t arrived yet. They can never be proved wrong as long as inflation is assumed to be just over the horizon. A gong should go off to stop the cake walk and let everyone find his chair. Whether intended or not, the ploy of inflation in the future is similar to the one where a policy is called an experiment. As long as it is succeeding, it is still an experiment and the jury is still out. Only if it ultimately fails is the experiment considered concluded. An experiment can never be refuted as long as the experiment continues, and neither can the absence of predicted inflationary consequences as long as we get to count future inflation.
Meltzer calls attention to the very large budget deficits in recent years, largely financed by Fed purchases of bonds:
“Never in history has a country that financed big budget deficits with large amounts of central bank money avoided inflation. Yet the U.S. has been printing money — and in a reckless fashion — for years.”
Notice the sleight of hand in that quotation as “central bank money” morphed into “printing money.” He knows exactly what has been happening, as reflected in this piece and other writings of his. He knows that the Fed’s bond purchases have created large quantities of bank reserves, much of which banks have allowed to remain on deposit at the Fed as “excess reserves.” If, by “money printing,” he means bank reserve expansion he is right by that strange definition. He and others often use the term “monetary base” in their unique definition of money printing, the monetary base being bank reserves plus outstanding currency The monetary base used to be called “high powered” money since both its components can be used as the basis for multiple monetary expansion of the banking system. They are correct that the monetary base — whose main component is bank reserves — has expanded tremendously. However, that is not printing money.
Neither rising bank reserves nor a rising monetary base has translated into what has generally been known as money in the context of printing money. Too much money can cause inflation because that’s what we all spend on goods and services. The most commonly used definition of money in recent years has been the M2 measure. The M2 money supply may be found in the Fed’s H.6. report. Just Google it.
At the time of this writing, M2 growth has been 6.9 percent over the past 3 months, 6.5 percent over the past 6 months, and 6.0 percent over the past 12 months. These growth rates are similar to what they’ve been for several years. They would be high under normal circumstances, but circumstances haven’t been normal. Since M2 growth times the velocity of M2 generates nominal income or nominal GDP, and since nominal GDP has been growing more slowly that M2, M2 velocity has by definition been falling. It wouldn’t change the argument if you use another measure of money, such as M1, which has been growing much faster than M2, since nominal GDP growth is what it is and you would just derive a sharper decline in M1 velocity.
Of course, Allan Meltzer knows all this and probably could express it better than I if he wanted to. But, apparently, he doesn’t want to. He prefers to portray money growth as wildly excessive and highly inflationary. It’s just that the coming inflation hasn’t arrived yet. But it’s coming. It’s been coming for five years now.
He does, however, begin his piece with an inflation alert. He says the Department of Agriculture forecast that food prices will rise as much as 3.5 percent this year. I don’t doubt that since I can’t find a decent avocado or lime that actually has juice in it. Surely he isn’t hanging his hat on weather related food price increases.
You don’t have to give up your faith in monetarism to acknowledge reality. I haven’t. All it takes is to distinguish between bank reserves and the monetary base on the one hand from M2 (and its velocity) on the other hand. It is the latter that drives inflation since that’s what the public uses as spending money. Meltzer says inflation is merely postponed indefinitely despite growth in bank reserves and the monetary base. I say inflation has been low because of slow growth in the money supply adjusted for velocity.