“A hundred million here, a hundred million there, pretty soon it adds up to real money.” That reputedly was Senator Everett Dirksen’s sardonic explanation of how minor pork barrel appropriations for special interests could affect the federal budget.
The great Republican from Illinois has been dead for some years now, but I wonder how he would categorize $921,100,000,000. Does nearly a trillion dollars constitute “real money?” That is the question the Federal Reserve Open Market Committee has to face Tuesday and Wednesday as it meets for the first time in 2002.
That sum is the amount by which the Federal Reserve let “M3″—a broad measure of the money supply—grow between December of 2000 and December of 2001. In relative terms, it amounts to nearly a 13 percent increase in 12 months.
The question is, is such monetary growth sufficient or is it excessive?
I’d argue that we are in danger of it being excessive.
Given the fact that the economy slipped into recession early last year, that the events of September 11 and its aftermath shook global confidence and that the U.S. economy is far more competitive and hence far less inflation prone than a generation ago, no harm has been done.
But it may be a good time to ease up on the monetary accelerator.
Given the magnitude of the political shocks in September, central bankers probably did well to err on the side of loosening. Moreover, “M1” and “M2″—narrower measures of the money supply—did not grow as rapidly as M3, posting increases of 8 percent and 10 percent respectively.
But it is an old axiom in economics that if the money supply grows faster than output for a sustained period, inflation has to result. Looking back, there are only two years in the half century since the Korean War in which M3 grew faster than in 2001. Only in 1971 and 1972 did broad money growth exceed 2001’s 12.86 percent.
For those too young to remember the 1970s, those were the two high inflation years that led President Nixon to impose wage and price controls in 1972, one of the most cynical measures in U.S. economic history.
Nor did the Fed let money grow this fast coming out of the past two recessions—those of 1991 and 1982. In 1992, money growth was less than 1 percent, and in 1993 the Fed actually let M3 shrink. George Bush Sr. may be correct that Alan Greenspan did nothing to help him in the 1992 election, but the Fed did not do the incoming Clinton administration any favors, either.
The recession may not be over, but reversing monetary policy is a lot like reversing an oil tanker. The bridge has to send orders to the engine room a long time before any noticeable change can be detected.
The monetary loosening that the FOMC approved in the first half of 2001 should just be taking full effect now. The additional lowering of target interest rates in the last half of the year has yet to be felt. So don’t be surprised if at least some members of the Committee feel it is time to staunch excessive money growth.
It is important to remember that, contrary to popular myth, Alan Greenspan does not dictate Fed policy. He will have only one vote out of 10 this week.
The Board of Governors is still short-handed, and Laurence Meyer, whose term ends Thursday, reportedly will not vote. That leaves five board members, two of whom are extremely green, and five district presidents, of whom four are old hands and one in his first year on the FOMC.
Two presidents, Cleveland’s Jerry Jordan and Minneapolis’ Gary Stern, have reputations as anti-inflation hawks who are extremely wary of excessive monetary growth.
The Fed, like the Supreme Court, is supposed to be unswayed by party politics, but 2002 is an election year. Any action it takes—or fails to take—may confer political advantage on one party or the other.
Given the fact that the central bank will have to slow money growth sooner or later, some FOMC members may prefer to get the bad publicity of a policy reversal out of the way eight or nine months away from Election Day, rather than in mid-summer during the heat of congressional campaigns.
It would be unusual for the FOMC to actually raise its target for the Fed Funds rate without any warning.
But I would not be surprised if the committee chose to take no action now and to issue a press release noting a change in its “bias” away from further easing and toward tightening. That would set the stage for a rate increase at the next scheduled meeting on March 19.
© 2002 Edward Lotterman
Chanarambie Consulting, Inc.