If You Read One Story About the Economy This Year…

…make it this one.

Fed: US consumers have decided to ‘hoard money’

One of the great mysteries of the post-financial crisis world is why the U.S. has lacked inflation despite all the money being pumped into the economy.

Well it’s not that big a mystery.  Part of the answer is has been the interest rates the FED has been paying on excess reserves that Congress approved with the 2008 TARP bill.  That’s given the banks more incentive to sit on those reserves rather than loan them out.  With the current low interest rates, it’s a safer and better deal to draw interest from the FED than take a chance loaning out the money for not a substantially greater interest rate, but with much more risk.

The St. Louis Federal Reserve thinks it has the answer: A paper the central bank branch published this week blames the low level of money movement in large part on consumers and their “willingness to hoard money.” The paper also cites the Fed’s own policies as a reason for consumers’ unwillingness to spend.

That seems like a cheap shot to the American consumer, but what they are really describing is the Velocity of Money, “The rate at which money is exchanged from one transaction to another, and how much a unit of currency is used in a given period of time.”  In other words, how fast is money changing hands, going from one transaction to another.   Right now this low money velocity may actually be a good thing because otherwise:

Under normal circumstances, according to the Fed analysis, when the money supply increases at a faster rate than economic output, which has been the case since the Fed has instituted its aggressive easing practices, prices should keep pace. Factoring in the growth in the money supply against output, inflation should have grown at a whopping 33 percent annually, when in fact it has been rising less than 2 percent.

33 percent inflation rate!  That is what we should have been dealing with under conventional economic theory!

The reason that inflation hasn’t kept up with gains in the money supply simply has been that people are sitting on cash rather than spending it, which has kept money velocity at historically low levels.

So that makes me wonder, what happens when the economy eventually recovers, normal economic resumes, and the money velocity returns to its normal rate?  It’s unlikely to happen under the Obama administration, unless there is a major turnaround of economic policies, but one assumes that eventually there will be an administration that will right the economic ship.  Will we have to deal with a massive burst of inflation just to finally recover from our sluggish economic growth?

 

Advertisements

2 thoughts on “If You Read One Story About the Economy This Year…

  1. There are two obvious possibilities, both bad.
    1. Go back to the strong dollar policy of the Reagan administration. You would have to raise interest rates to contact the money supply. Unfortunately, this usually produces a severe economic recession before the money supply stabilizes and growth can take place.
    2. Because the US will be about 20 Trillion in debt by 2017, use this vast amount of currency to your advantage. Crank up the printing presses and monetize the debt. When you reach a manageable debt level you introduce a new currency and a strong monetary policy. Of course, this wreaks your economy, but it does work. Does anyone remember the Israeli Pound?, or the Israeli Shilling?

    Like

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s