Sunday, September 28, 2008

About The Recent Surge In The U.S. Monetary Base

While this development has gone unnoticed in the "mainstream" financial media, some Austrian-leaning commentators have recently made a big deal of the recent massive surge in U.S. bank reserves and therefore also by extension the Fed balance sheet and the monetary base.

Between the two weeks ending September 10 and the two weeks ending September 24, the monetary base rose from $843.8 billion to $911.4 billion. Although a small part of that increase reflected an increase in currency in circulation, the overwhelming majority of it reflected higher bank reserves.

Looking at the more frequently update data on the Fed balance sheet, it appears that even these numbers underestimate the surge because they are two week averages. If we look at week averages and end of week levels, then the increase is even more dramatic than that.

As is apparent by the explanatory text inserted in the top of both the Monetary base and the Fed balance sheet statistics pages, the reason for this surge is the various schemes the Fed now uses to try to aid banks.

How much does this matter then? Not necessarily as much as some people think. As I've explained before, the monetary base is in itself unimportant for the economy. What matters is instead money supply, so unless the higher monetary base causes money supply to rise, it will have no impact on the economy.

However, to the extent this in fact causes money supply to rise, it will have an impact on the economy. And given the fact that banks usually don't like holding excess reserves, there is every reason to believe that at least some of the increase in reserves will be used to expand bank balance sheets, which in turn will likely cause money supply to rise. The general distress these days will however likely mean that banks will in fact hold some excess reserves, limiting the short-term effect on money supply. The general distress itself will also make banks more reluctant to lend, and the general public also more reluctant to borrow, which will also have a deflationary effect.

Just what the net effect of these two counteracting forces, the inflationary effect of the Fed schemes and the deflationary effect of the general financial distress, will be remains to be seen. I will keep a close look on coming money supply and bank credit releases. The latest bank credit release BTW featured a massive surge in bank credit. Bank credit contracted between March and June this year, but started to slowly recover after June, and in the week to September 17 it then suddenly surged by $134 billion, or nearly 1.5% in just a week. That could be just a temporary spike, but it may also be an effect of the inflationary Fed schemes. Again, we should watch coming releases to see whether this was just an erratic spike or whether it indicates that the Fed is successful in their attempt to create inflation.


Anonymous Anonymous said...

what about this. From Bloomberg:-

"Congress’s $700 billion legislative compromise to revive credit markets would also expand the Federal Reserve’s power to manage short-term interest rates.

The draft bill gives Fed authority as of Oct. 1 to pay interest on reserves held at the central bank by financial institutions, according to a copy obtained by Bloomberg News. That would encourage banks to deposit excess funds with the Fed rather than dumping them into the money markets and distorting its overnight federal funds rate…"

Wont that make the banks do as they are told?

11:24 PM  
Blogger rubenh ( said...

this is scary times

3:47 AM  

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