Wednesday, November 3, 2010

What Money Stock Growth is Telling Us

The year-over-year rate of growth of the money stock measures has never declined during the Great Recession of 2008-2009.

The recession began in December 2007. In January 2008 the year-over-year rate of growth of the M2 measure of the money stock was 6.0%; the M1 measure was growing at 0.5%. Currently, the M2 measure is growing at a 3.0% year-over-year rate of growth; the M1 measure is growing at 6.3%

The interesting thing about the behavior of these money stock measures is what happened within each measure. I have regularly reported on this behavior over the past 18 months or so. (See, for example, “The Recent Behavior of the Monetary Aggregates”:

Looking at the monetary aggregates over this period of time reveals two movements. The first movement is the transferring of funds from small time and savings deposits and short-term money funds into transaction balances. The second movement is the transferring funds from thrift institutions to commercial banks. These movements can be attributed to the low interest being paid on these accounts and in these funds and to the employment uncertainty that hovers over many families in the United States. This is not a real positive sign in terms of a country attempting to get its economy going again.

Over the past three months, the Federal Reserve System has ended its “exit strategy” and taken a more neutral stance with respect to monetary policy. (See At the present time, the world seems to be waiting for another effort at Quantitative Easing. (See

Regardless of what these “grand” strategies are and what they might accomplish…or, not accomplish…it is still instructive to see what people actually seem to be doing with their money.

Basically, when looking at the monetary aggregates we see the same behavior over the past several months that we have seen exhibited by the private sector over the past twenty-four months. People continue to transfer their wealth into transactions balances and currency holdings while reducing wealth held in the smaller savings deposits and in retail money funds.

That is, the families and individuals still believe that they can most be prepared for the future by keeping their money is ways that can be spent without having to transfer funds from other accounts in order to be able to spend them. Any interest that might be earned on these latter balances is just too small to warrant these people from being any more less liquid.

Overall, the M1 measure of the money stock in the third quarter of 2010 was 5.3% higher than it was one year ago. The quarterly year-over-year growth rates for M1 fell during the year, averaging 7.9% in the first quarter of 2010 and 5.5% in the second quarter.

The M2 measure remained relatively constant in the first and second quarter of this year, averaging 1.9% and 1.6% respectively, but increased at a 2.5% rate in the third quarter. The non-M1 component of the M2 measure only increased at a 0.5% year-over-year rate of growth in the first quarter; it rose to 0.7% in the second quarter; and rose by 1.8% in the third quarter.

The biggest change contributing to the rise in the non-M1 component of M2 was the slowdown in the rate of decline in money held in Retail Money Funds. In the six months of the year, these accounts declined at a rate slightly more 25%. However, the rate of decline dropped to about 22% in the third quarter. Overall, retail Money Funds dropped by more than $160 billion from September 2009 to September 2010.

The decline in small time deposits stayed around 22% all year. Small time deposits fell by almost $280 billion from September 2009 to September 2010.

Where have these funds gone? Primarily into transaction balances.

The growth rate of demand deposits at commercial banks has remained relatively robust over the past year. This growth, connected with the decline in small time accounts and retail money funds, is the reason why the rate of increase in the M1 measure was greater than the growth rate of the M2 measure.

Demand deposits rose at a 7.6% year-over-year rate of increase in the first quarter of 2010; the growth rates for the rest of the year were 6.3% in the second quarter and 8.5% in the third quarter.

The interpretation of all this is as follows: people have, once again, begun re-allocating more of their wealth into transactions balances and currency. Although this movement slowed earlier this year, it began to pick-up once again in the third quarter.

In a real sense, this is not encouraging. To me this movement is what happens when people and businesses transfer their wealth into forms that are convenient for daily needs in order to purchase necessities. This deposit growth is not coming because the Federal Reserve is pumping a lot of base money into the banking system. The growth is not coming because the commercial banks are lending…they are not lending. This movement of funds seems to be to purchase the basic goods needed to live and survive.

The good news is that the money stock measures are growing. The not-so-good news is that the money stock growth is growing because people and businesses need to keep their funds very liquid for the purpose of daily living.

I cannot believe that a new round of quantitative easing is going to change this picture.

NOTE: Money going to Institutional Money Funds actually began to increase in absolute value in July 2010 and continued to increase through September. The year-over-year rate of decline in these monies is still quite large (-23% in the third quarter) but it is a smaller decline than from the first two quarters of the year.

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