Monday, December 28, 2009

Mankiw Clues Us In: Monetary Base Is Not Money Supply

I have been pointing this out for months, now even Harvard's ultimate textbook salesman Greg Mankiw gets it. He writes:
An article in Saturday's Wall Street Journal says that some big-league investors are betting that inflation will rise significantly. The reason? "The nation's exploding monetary base is a harbinger of inflation." Is this right? Probably not.

It is true that the monetary base is exploding... Normally, such surge in the monetary base would be inflationary. The textbook story is that an increase in the monetary base will increase bank lending, which will increase the broad monetary aggregates such as M2, which in the long run leads to inflation.

That is not happening right now, however. The broader monetary aggregates are not surging. Much of the base is instead being held as excess reserves.
So you have two ways to learn your economics, go to Harvard and get your economics filtered through Greg Mankiw or you can read EPJ, invest the tuition money it would have cost you to go to Harvard AND get the same analysis seven months earlier.

9 comments:

  1. How does the following comments from James Turk play into this?:

    "Much has been made of the huge bank excess reserves “sitting idle” at the Fed. It has been said that hyperinflation is not possible when the banks are sitting on such huge reserves, instead of lending them into the economy. This thinking is flawed because it ignores that there are two sides to the Federal Reserve’s balance sheet. Those reserves are not just sitting there, as if they were in a vacuum. These reserves have funded the Fed’s purchase of US government debt, putting it and the US dollar on the road to hyperinflation."

    Source:
    http://tinyurl.com/yezsdgg

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  2. Bob: I read Greg's article this morning and was thinking i read this already somewhere else :)

    I could figure out what he was going to say by the title of his article, thanks to you :)

    The question is, now that he realized this "truth", how his future economic forecasts will change?

    There is hope, maybe they are just slow. Maybe the mainstree media/textbooks will eventually "get it" afterall.

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  3. @anonymous

    It is not entirely clear what the Fed bought, but for arguments sake let's say it is Treasury securities. The Fed buys the Treasury securities by issuing a check which is deposited at a bank where the bank puts the money in excess reserves. It is not in the system.

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  4. Are not the funds that were used to buy the Treasuries immediately spent on public (state) projects (or to pay government bills) thus entering the economy and creating an increase in the money supply? Or what am I missing?

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  5. "The Fed buys the Treasury securities by issuing a check which is deposited at a bank where the bank puts the money in excess reserves. It is not in the system."

    Wow this is confusing.

    So Oby invests in infrastructure by borrowing from the Fed. You seem to say the company just deposits this in the banks and that the banks hold the money in excess reserves. So no inflation.

    But surely by investing in infrastructure payments are being made to construction companies who are paying workers and suppliers who are buyings goods and svcs in the shops.

    Surely that is expansionary and will kick start the price inflation people like myself are worried about?

    What have I missed?

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  6. @anonymous 11:51 and @ Not An Economist

    Note:

    A. I note in my comment that I am not sure the Fed bought Treasury securities.

    B. The Fed generally, not always, but generally buys Treasury securities in the open market buying through primary dealers. The money from these purchases does not end up with the Treasury. it ends up with the primary dealers. If the PD's put it in excess reaserves, it is not in the system.

    But again, I think Turk is off on his belief that the Fed has been buying treasury securities. I think it has been junk syndicated securities.

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  7. @Robert Wenzel re:
    B. The Fed generally, not always, but generally buys Treasury securities in the open market buying through primary dealers. The money from these purchases does not end up with the Treasury. it ends up with the primary dealers. If the PD's put it in excess reaserves, it is not in the system.

    Doesn't this omit the fact that the PDs use this money from the Fed to purchase more treasuries? Unless the PDs can print dollars, it seems like the funds eventually make their way to the Treasury Dept to be spent into the real economy (through entitlement programs, defense, etc).

    In other words:
    Option A = Fed --> PDs --> Treasury --> Real Economy, or
    Option B = Fed --> Treasury --> Real Economy

    (the above assumes at least a portion of the excess reserves are being used to fund Govt deficits instead of 100% of them being used to buy up "junk."

    Thoughts?

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  8. Here's a breakdown of the Fed's assets as of last July, I think.

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  9. So if the Fed buys junk syndicated securities does that not free up capital to the sellers of these securities which are then free to enter these funds into the economy?

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