Earlier this week I posted some background material recalling how real interest rates were negative in the mid ’00s, thus inducing wild/out-of-control borrowing (all of which was looking for places to invest—think CDOs). I was planning to use these data to back up my sense that the Fed’s recent rate cut was at best insufficient (I may still be right) and at worst dangerous (looks like I was wrong). The latest data1 (released on Friday, a few days after I posted) show that the Fed is pumping unfathomable amounts into the monetary base, and it’s just barely keeping monetary supply from falling off the table.
To get a sense for what the Fed has done recently, take a look at the utterly unprecedented jump in the adjusted monetary base2:
Your eyes are not deceiving you: the Fed has pumped an unbelievable amount of money into the monetary base. Classic monetary policy at work, right? Well, it’s certainly an implement out of the classic monetary policy toolbox, but this is an unprecedented action:
Now the critical question: is it working? Well, a little. In comparison to the monetary adjustments made after 9/11 to offset the economic shock, the current adjustments are three to four times bigger, but they’ve had a substantially smaller impact on the broader money supply3:
Compare the two red arrows in the second figure to the orange arrows in the figure immediately above. The absolute adjustment to the monetary base (red arrows) in 2001 was somewhere between a quarter and a third as big as the utterly unprecedented influx the Fed just let loose, but the results (orange arrows) is barely noticeable. What’s going on? The simplest explanation I’ve heard comes from Bob Brinker, who explains that M2 has seen the impact of the past two months’ massive evaporation of wealth, while the absolute currency (monetary) base hasn’t. To my eyes, we can therefore visualize the “spread” between BASE and M2 on the right-hand side above as that very evaporation itself
Speaking of spreads, it looks like there’s another indicator that the Fed’s policies are working a little. The TED spread4 has improved dramatically:
Recent TED Spread history. 5
All of this points towards a similar conclusion to the one I hinted at in my post earlier this week: monetary policy alone isn’t going to solve this problem. A solution will require some time and some fiscal policy—both of which will have to wait for the end of the lame-duck period and thus for 2009.
- the St. Louis Fed reports most of its major money supply “observations” every week, on Fridays [↩]
- the Fed series is called “BASE” and you can find it, and the rest of the measures (“series”) I am referring to in this post on FRED at http://research.stlouisfed.org/. The BASE data, for example, can be found at http://research.stlouisfed.org/fred2/series/BASE. [↩]
- as measured by a different Fed series, called M2, which is physical currency (M0) plus demand deposits such as checking (M1) plus all manner of time deposits (savings, CDs, etc.). For an explanation of the various money supply measures, see http://en.wikipedia.org/wiki/Money_supply. [↩]
- difference between LIBOR and the 91-day Treasury Bill, roughly indicating the price of the credit supply [↩]
- source: Bloomberg, http://www.bloomberg.com/apps/cbuilder?ticker1=.TEDSP%3AIND [↩]