Economists eye surging cash provide as inflation fears mount

By Karen Brettell

(Reuters) – Some economists are warning that the rising money supply could exacerbate a surge in US inflation, which has been accelerating as fast as it has been for more than a decade.

According to the Center for Financial Stability’s (including Treasuries) Divisia M4 index, money supply – which measures the circulation of currencies and cash – rose 12% year over year in April.

The measure has run between 22% and 31% every month since April 2020, fueled by unprecedented economic stimulus from the US Federal Reserve and the US government. This contrasts with an annual growth of around 3-7%, which was common from 2015 to the beginning of 2020.

“This money supply growth is just so much faster than anything we’ve seen before,” said Desmond Lachman, resident fellow at the American Enterprise Institute. “It’s a reflection of a huge backlog in the economy … it’s hard for me to understand how not to get inflation.”

Money supply https://fingfx.thomsonreuters.com/gfx/mkt/yxmpjadyyvr/Divisia%20Index.JPG

Federal Reserve chairman Jerome Powell said Wednesday the Fed would adjust its policy if inflation expectations get too high, and the central bank is postponing its first forecast rate hike from 2024 to 2023.

So far, money supply growth has not been a major driver of inflationary pressures, in large part because banks hold cash as deposits.

The Fed has also downplayed the link between money supply and inflation, and Powell said in February that monetary measures had not been a major determinant of inflation “for a long time”.

In fact, the central bank’s bond purchases after the financial crisis did not trigger the expected inflation, as it took the economy years to recover and the money supply at that point was falling.

This time around, however, banks are struggling with record deposits after the US government increased government spending while the Federal Reserve purchases unprecedented amounts of bonds.

The story goes on

There is concern that businesses, investors and consumers are drawing up their deposits and spending, while banks increase lending as the economy reopens. Some economists fear that such a confluence of factors could lead to demand growing faster than economic output and prices rising.

Money supply growth was a factor in the high inflation in the 1970s, when the government ran budget deficits and the Fed introduced loose monetary policy to stimulate employment.

Bank reserves rose to a record $ 3.89 trillion in April and are projected to surpass $ 5 trillion this year as banks sell bonds to the central bank.

Meanwhile, commercial and industrial lending by commercial banks fell from a record $ 3.04 trillion in March 2020 to $ 2.55 trillion in May, although it continues to rise above the February 2.36 trillion level 2020 lie.

The Fed may be reluctant to hike rates as the Treasury Department struggles with record debt levels even if inflation rises, said William A. Barnett, director of the Center for Financial Stability.

However, if rates on primary market lending rise without interest rates on reserves rising accordingly, it could lead to an “explosion in lending,” Barnett said. “The risk to the economy is future inflation.”

Barnett believes that much of the Fed’s bond purchases will be permanent, effectively monetizing the debt, as it did during World War II, when most of the Fed’s bond purchases were irreversible.

The Fed has announced that it will eventually expire its bond purchases when the economy recovers, after which it will have to decide whether to decrease the overall size of its asset holdings when the bonds in its holdings mature.

When it “normalized” its policy from 2014 onwards, the Fed first reinvested maturing securities to keep its overall balance sheet constant, but then allowed the balance sheet to shrink.

This time around, the Fed is far from developing a plan to actually reduce its holdings.

However, some fear that if inflation is already rising, it may be too late to act.

Last week’s data showed that consumer prices rose 5% in May, the largest annual increase in 13 years.

“The rise in inflation could be a bit higher than the Fed has gambled away once inflation expectations are embedded in the system,” said Kim Rupert, managing director of Action Economics.

(Reporting by Karen Brettell; Editing by Dan Grebler)