Aug 5, 2021 3:26 p.m. ET

Phil Gramm and Thomas R. Saving present their commentary “How the Fed is hedging its inflation bet“(Aug. 2) by stating a fact:” The growth of the money supply M2 has declined from around 25% in 2020 to around 10% on an annual basis in the first six months of 2021. “They then explain that this The slowdown has occurred because, since April, the Fed has “drawn nearly $ 1 trillion in liquidity from the financial system” through its reverse repurchase facility. Your argument is based on a flawed theory and does not hold water.

The idea that a trillion dollars in reverse repos reduced the money supply by just a dollar is nonsensical. Reverse repos are a Fed liability and an asset of the banks and money market funds (MMMFs) that lend funds to the Fed through reverse repos. Deposit liabilities from both banks and money market funds are part of the money supply. These liabilities are unaffected by the choice of banks and MMMFs whether to invest their assets in the Fed’s reverse repo facility, Treasury bills or elsewhere. In contrast to the gram-saving analysis, the Fed’s reverse repo program has no impact on the money supply.

John Greenwood

Chief Economist, Invesco

London