The Federal Reserve recently discontinued updating the M1 and M2 weekly money supply series and is instead updating the series monthly.
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Steve Hanke, professor of Applied Economics of Johns Hopkins University, said that this change reflects a change in attitude from the world’s largest central bank on the importance of looking at money supply.
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See Full Interview Transcript Below
David Lin: The Federal reserve has discontinued publishing their M1 and M2 money stock series here to discuss the implications and what this means and why they’ve done this is an expert on Monetary policy Steve Hanke professor of applied economics at Johns Hopkins university professor Hanke welcome back let’s talk about this why has the Federal reserve discontinued these series they’ve been publishing this since the 70s you told me offline
Steve Hanke: Yes they’ve been publishing various Monetary statistics and statistical series since 1971 so-called M1 M2 M3 and so forth but they’ve changed the definitions and the frequency with which they report them and they’ve discontinued some series I think that before we get started David let me remind you of President Bill Clinton’s maxim he had a maxim that was it’s the economy stupid and my maxim it’s the money supply stupid and the reason for that is that the money supply determines the course of nominal GDP and nominal GDP includes real growth and the inflation rate that’s what makes up nominal GDP so if we go back let’s kind of get the story before we get into the weeds on the technical statistical series and to set the stage is really what people have to get in mind measuring money and the money supply became very important in the United States when Paul Volcker became Chairman of the Federal Reserve in 1979 and shortly after he became Chairman he said that we are going to start watching the money supply it is the money supply stupid and the reason for that is that the inflation rate in the united states when Volcker entered the scene was 13.3 percent low double digit inflation it was it was stagflation in those years and so he slowed the money supply down measured by M2 that that particular version which actually has nine components in it starting with currency and then demand deposits and savings deposits and so forth and so on but M2 he was using as his measure he cranked it down to seven percent put a squeeze on and by 1982 the inflation rate in the United States had been squeezed down to 3.8 percent but there was a problem and that is we experienced two recessions one in 1980 which was very mild and then a fairly severe one in 1982 so the squeeze that he put on got inflation down but it squeezed a lot of real GDP out of the system now the reason for that was due to the money supply measurements Volcker had the thing right it was the money supply he had to focus on the money supply he had to slow it down but he thought by looking at the Fed’s measures of M2 that he was slowing it down to around seven percent per annum growth in fact if you measured the money supply growth properly money supply was actually contracting it was going negative on him but he didn’t know that so the key thing is you have to measure the money supply correctly you’ve got to get the correct measure on your dashboard or you’ve got a big problem so it is the money supply that’s very important and when I say the money supply measured properly actually went negative what do I mean what was going on there’s something called the Divisia measure of money supply and it happens that the world’s expert on this is Bill Barnett professor at the University of Kansas and also a fellow at the Center for Financial Stability in New York where Divisia measures of the money supply are actually published now what is Divisia well if you look at the normal measure of the money supply whether it’s M1 or M2 it’s those are called simple sum indices in other words you have various components I said there were nine components in M2 and you just add those nine components up and that’s a simple sum and that gives you the total M2 now Divisia does things differently Davisia says yeah there are nine components in M2 but each one of those has a different degree of “moneyness” in it in other words currency gets a hundred percent weight because it you can use it immediately for a transaction a checking account is also an M2 and that that gets a also a 100 weight but other things that are in the components the other components get less than 100 percent weight and that weight changes around depending primarily on the interest rate let’s say the interest rate in Volcker’s time on savings accounts went to the moon I mean it was up in double digits well in that case the opportunity cost of you exchanging your savings account or your money market account or whatever the component happened to be in the money supply that you were measuring you’d be very reluctant at those high interest rates to actually cash out of your money market account entertain cash that is money and can be used directly in transactions so as a result of those high interest rates the Divisia measure of M2 actually went negative in the early 80s and that would have been the proper measure that would have been the right thing to have on your dashboard unfortunately the Fed wasn’t producing it and Volcker didn’t have it so Volcker thought he was not squeezing it excessively he thought he was right on a money at squeezing things down to about seven percent M2 growth with his simple some Fed number but the real number was negative and that’s why we had these two recessions
David Lin: Yeah I want to ask you about what you said earlier on the priorities of the Federal reserve so before Volcker realize money supply was important as a tool for measurement but now you’re saying that the Federal reserve no longer thinks that money supply is important is this a change in Monetary policy what’s with this change in attitude where did it come from
Steve Hanke: it’s with Chairman Paul it’s he is very explicitly claims that money doesn’t matter I mean in recent testimony he’s basically said that money and the measurement of money doesn’t really matter because it it’s unrelated to inflation and M2 that is unrelated to inflation so that was a fairly explicit he said
David Lin: He said specifically the correlation between money supply growth and inflation historically that correlation is not strong is that is that even correct professor
Steve Hanke: Yeah that that is incorrect he said M2 which is the broadest measure that they’re reporting at the Fed now if you measure broadly at M3 or M4 that what he said is not correct if you if you measure everything that has “moneyness” in it all they’re actually M4 what professor Burnett’s measuring M4 Divisia has 14 measures in it including treasury bills are even included as the last component now they get a lot less weight in the Divisia Index than does something like currency or checking deposit but they still get weight and there are a lot of treasury bills out there so even if you’re weighting them lightly the total amount adds up to a big number and
David Lin: When I told my when I told my peers they were doing this my the first response I got was this sounds suspicious it’s a little bit fishy maybe the Federal Reserve is trying to hide something
Steve Hanke: Well what they are trying to hide something they’re they they’ve changed the reporting frequency on M2 to monthly now not weekly so they don’t want people paying attention to money supply growth and the reason why is that in principle they don’t think it’s important they want to deep six the monetarist basically and push them off to the side they want to bury Milton Friedman once and for all and be done with it and their preference probably would be to not report any Monetary statistics now Friedman of course was a monetarist and was looking at the money supply correctly and if you measure it broadly correctly like Barnett is with the Divisia indices you get a very nice relationship between the growth of broad money measured by Divisia M4 and the growth and nominal GDP
David Lin: So let me ask you this Powell has said that he does not expect inflation to be a long-term persistent force do you think maybe they’re they’ve discontinued publishing these money supply series so that narrative could be better to be supported by existing data
Steve Hanke: Well to give you a short answer yes they don’t want people looking at these money supply numbers and the reason why that chart that you have up there on the wall shows that M2 is spiked up now what that means in most people’s mind the money supplies exploded and we can expect a lot more inflation going forward now the Fed wants to control inflation expectations what people think about inflation and the best way to control that is just take that chart off the wall get rid of it that’s the name of the game it’s to control monetary inflation expectations and if you don’t report Monetary statistics on a on a frequent basis and have it as a headline kind of number like in the old days by the way the weekly reports under the Humphrey Hawkins act those weekly reports were paid attention to by everybody I mean they were reported and highlighted in the Wall Street journal all the financial press now you’ve got to hunt around almost be an expert to figure out what in the world’s going on or go up to the center for financial stability in New York and get the number or something like that so this is this is to dampen down they don’t want to get the public excited about inflation and Powell’s saying number one we’re not going to be reporting Monetary numbers even the incorrect kind of numbers are incomplete numbers if they have an M2 we’re not going to report this every week we’re going to keep those to a monthly basis so that’s one thing going on this started by the way in 2006 with Bernanke the Fed Chairman Bernanke was a Chairman of the Fed then they stopped reporting M3 completely in 2006 so there have been there have been a couple of big changes recently and this is trying to deep six monetarism deep six the importance of money control inflation expectations all these things are all wrapped up in one
David Lin: So they’re trying to get they’re trying to get rid of monetarism and replace it with what
Steve Hanke: Professor well they want you to start looking at things like interest rates for example that that would be one thing but interest rates are very misleading indicator of Monetary policy let me just take you through this sequence David let let’s say that we’re tightening Monetary policy now what happens first is that the Fed says okay we’re going to tighten Monetary policy enter it short term interest rates go up the money supply starts dropping inflation starts dropping because nominal GDP is dropping and then on a sustained basis what happens to interest rates they go down when the money supply the money supply goes down inflation goes down and sustained long-term interest rates go down not up so that’s why you get a confusing signal they say oh we’re going to tighten and people say oh yeah interest rates are going up interest rates do go up but eventually what happens on a sustained basis they go down now if you’re loosening you get exactly the opposite happening you say oh we’re going to loosen up Monetary policy and goose things a little bit interest rates in the short term temporarily go down the money supply goes up inflation goes up and on a sustained long-term basis what happens to interest rates they go up they don’t go down
David Lin: So are you saying we’re still in a loosening period or are we in a tightening period now
Steve Hanke: Well now we’re in a loosening period the money supply is skyrocketing and what that means is yeah and the interest rates when they first started a year ago interest rates went down down down right now the money supply key is bubbling along cranking along at over Divisia M4 over 28 percent per annum greatest expansion since 1943 and broad money and what happens inflation starts going up and interest rates starts going up that’s why the bond market’s going wild long-term interest rates are going up they’re not going down so that’s one reason that the Fed they don’t want you looking at money they want to talk about interest rates that’s a very misleading thing to be looking at a very confusing thing also inflation because they’re inflation targeting that gets to another measurement problem
David Lin: That yeah I was going to ask you about that yeah people agree with you we should have inflation but the CPI hasn’t shown that yet so either we haven’t had the CPI numbers reflect higher levels of inflation yet maybe it’ll take some time or maybe the CPI itself is not an accurate indicator of inflation where do you stand on this
Steve Hanke: Well it is one measure but there are a lot of measures the CPI now in the United States is going up at 1.7% per annum and the but the core inflation number excluding volatile food and energy prices is only going up at 1.3 percent the producer price Index for raw material inputs going up at 2.8 percent food is going up the food inflation Index is going up at 3.6 percent so you’ve got all kinds of indices everything different kinds of baskets in various indices so the question if you’re going to have an inflation target and you’re the central bank well how do you measure it what is inflation and that gets in well what’s in the basket and then how do you accurately measure what’s in the basket I mean do you measure listed prices on things or do you actually measure what people actually pay for something when they buy it on a discount or if the item is purchased in a large bulk quantity they’re getting a lower price than the list price so you have all kinds of problems with the with these price indices so again it’s a very fuzzy kind of notion what price Index is appropriate for the Fed to be trying to target the best thing is to go back to the money supply it’s the money supply stupid
David Lin: Let me tie all this together now professor one more question one of the tenets of Modern Monetary Theory MMT is that an increase of the money supply doesn’t necessarily have to lead to inflation do you think that’s the attitude the Federal reserve is adopting and this is potentially why I think they’ve stopped publishing M1 M2
Steve Hanke: Yeah I think de facto the answer is yes I mean you’ve asked me a rhetorical question in a way and you you’ve obviously sniffed the thing out you’re like a good hound dog who’s sniffing on the trail or something and I think you’re right on the money
David Lin: I don’t want to make assertions for assumptions I i asked a question hoping maybe you might say no I mean I don’t know but you so
Steve Hanke: Yeah I’m saying yeah
David Lin: Okay very good Steve thank you very much and we’re going to be following up with you a couple of very shortly and I want to talk about failed currencies it’ll be a very good conversation for the next episode but thank you for coming on today
Steve Hanke: Thank you for inviting me have a good day you too
David Lin: And thank you for watching Kitco news I’m David Lin
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