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The Fed raised interest rates seven times last year.
Andy Jacobson/AFP/Getty Images
The Federal Reserve will face important decisions in the coming weeks. The market expects the central bank to raise interest rates by a quarter of a percentage point, signaling a significant slowdown in the historic pace of rate hikes.
If dialback is implemented, it is for good reason. start workingAnnual inflation fell for the sixth month in a row in December and looks set to continue decelerating.
There is another sign that the Fed’s rate hikes are working. Growth in M2 (a measure of the money supply in the economy that includes currencies in circulation, retail money market fund balances, savings deposits, etc.) has slowed over the past two years after a surge in 2020, but the December figure showing a decline.
Money supply growth in December hit a record low of -1.3% compared to a year ago, marking the first ever drop in M2 based on all available data. The Fed started tracking this indicator in 1959. November’s growth rate is already 0.01%, and in February 2021 he is well below the 27% growth rate peak.
The decline shows a strong pass-through of the cooling economy and rising interest rates, and appears to fuel fears of a recent recession. But a significant economic downturn is not what the indicators are telling us. M2 is still 37% Higher than pre-pandemic, despite experiencing one of the sharpest slowdowns. In other words, the amount of liquidity in the system remains high, indicating that more needs to be done to normalize the economy, economists say.
“Homes still sit on many of these [2020] say deposit viral acharyaformer Deputy Governor of the Reserve Bank of India and current economics professor at NYU Stern, cites the stimulus checks that led to a surge in bank deposits in 2020.
That’s not the only reason M2 has surged, it’s been falling rapidly. To that end, we can look at the movements of the Fed’s balance sheet. “Quantitative easing” or bond purchases by the Fed during the pandemic have revitalized the economy and central bank balance sheets, pushing them to nearly $9 trillion. increase. reduced liquidity.
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The Fed’s total assets fell 5.3% on January 18 from its peak last year, but its balance sheet remains more than double the $4.1 trillion it had in February 2020 before the pandemic began. That’s a lot of money, but the Fed doesn’t want to risk disrupting financial markets by accelerating tightening any further.
The Fed “doesn’t want to turn monetary tightening into an episode of financial instability,” said Acharya, along with three other economists. published a paper in August entitled Why Shrinking Central Bank Balance Sheets Is A Difficult Task
Ultimately, as M2 retreats further, declining money reserves will weigh on demand, “bank loans and other loans for households, businesses, and financial market transactions,” said Nathan Sheets, Citi’s global chief. should continue to help keep inflation under control, as it reduces the “ability of the central bank to support funding”, Economist.
But investors shouldn’t assume that a decline in M2 automatically signals a slowdown in the economy, writes Merion Capital Group’s Richard Farr. M2 “will have to drop another $1 trillion at least,” he said.
It’s a long way.
Please contact Karishma Vanjani at karishma.vanjani@dowjones.com.
