September 27, 2022
When banks lend to consumers and businesses, they put the proceeds into a checking account. At that point the money supply begins to grow.
In March and April of 2020 the Federal Reserve purchased $3.0 trillion of purchases of U.S. Treasury securities and flooded the banking system with reserves in an effort to lift the economy out of the deepest recession in our history In those two months M-2 grew at annualized monthly growth rates of 42% and 77% respectively. Its year-over-year growth peaked at 27%. It has slowed in the months since then. In the past year its growth rate now stands at 4.1% annual rate.
Those are funds that businesses can use to pay their workers, pay the rent, and keep the lights on, or that consumer can use to pay their rent or mortgage, their car loan, or buy food.
It is important to understand that M-2 typically grows at about a 6.0% pace month after month. The chart below shows how the level of M-2 has risen far above its normal 6.0% trendline. It is currently $3.8 trillion above its normal growth path. Thus, there is roughly $3.5 trillion of liquidity slopping around in the banking system which can fuel consumer and business spending for months to come.
That excessive liquidity will almost inevitably keep the inflation rate elevated. In the past year the CPI has increased 8.2%. The core CPI has risen 6.3%. This core rate of inflation may slow somewhat in the months ahead. We expect it to increase by 6.0% or so in 2022 and 4.2% in 2023. A return to a 2.0% inflation rate is not yet in sight.