I am not so sure that such a narrow focus on the monetary base as the de facto cause of current economic problems is a safe way to be conducting monetary policy. Agreed, in a general equilibrium, and in most normal economic scenarios, increasing the monetary base is going to stimulate economic activity – give banks more deposits to lend at an acceptable margin and they are likely to do so – but I am concerned that today’s monetarists have lost the plot.
If we look at the relationship between M2 and the monetary base, we would be forgiven for thinking that up till the recent crisis the Federal Reserve had monetary policy under control:
We can see a rather well defined and stable relationship between M2 and the monetary base from the 1990s to the start of the current crisis, a period itself associated with low inflation, fewer and less pronounced recessions etc. Although when we look at the detail we find that the actual point in time relationship between M2 and the monetary base is less well defined:
However, when we broaden out the relationship to M3, which was unfortunately discontinued, we see a potentially greater economic impact:
It gets worse when we look at the relationship between total US economic debt (ex financials) relative to the monetary base:
The relationship between the monetary base and broad economic activity has actually been much more dynamic and it is the issue of the impact of excessive debt on the financial system and on the economic engine that is the real fundamental problem at the present moment in time.
The actual monetary stimulus would appear to be not just well in excess of what a normal and balanced economy could cope with, but well in excess of what the financial system needs to stimulate lending.
That is, unless of course, if we are going stimulate any economic activity, whether it has a viable return or not. Personally, the Federal Reserve and its global Central Banking fraternity, plus academia, have a lot to answer for in terms of the quite shocking structural economic imbalances that were allowed to build up in the many many years leading up to 2007. This may well be the last kick of the can for monetarism as we know it.