April 27, 2023

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%.  The Fed kept purchasing securities until December 2021 which kept the money supply growing at a rapid pace.  It has actually caused the money supply to decline since the beginning of this year.

M-2 consists of 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.  Thus, it is a measure of liquidity in the economy.

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 rose far above its normal 6.0% trendline.  Even after declining in recent months it is currently $1.9 trillion above its normal growth path.  Thus, there is roughly $1.9 trillion of surplus 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 5.0%.  The core CPI has risen 5.6%.  This core rate of inflation may slow somewhat in the months ahead.  We expect it to increase  4.7% in 2023.    A return to a 2.0% inflation rate is not yet in sight.

Stephen Slifer


Charleston, SC