Above is a chart of M2 money supply.
Without doing a deep dive, this measure should just be understood as the basic amount of money in circulation.
The Fed considers this measure as a possible indicator of future inflation.
Now, of course, money supply increases over time as a certain level of inflation continues to exist year to year. As a basic measure, M2 doubles every ten years or so.
Well, the pandemic ended that gentle slope as the government began to dole out money to answer the challenge (we can get into right or wrong later). Regardless this left a spike in M2 that does appear to have had an impact on inflation.
So, what happens after this ramp?
The Fed, in its pursuit of price stability, sees its job as having to now pull money out of circulation. It is doing this through QT (or Quantitative tightening). In essence, they sell securities (Gov’t bills/bonds) to soak up the excess money.
As we can see from the chart this has been working. Inflation has been dropping and recent stories regarding the slowing spending habits of individuals have begun to pop up in the news.
Where is the worry?
As M2 is reduced then economic activity will drop. Do this too much and you put the economy into a stall.
Knowing this balance exists, what do I think is the Fed’s target for M2?
My conclusion is that the Fed is trying to reduce M2 to the point that it returns to its roughly linear trajectory to doubling every ten years. This is a more normalized rate. I think this is one of the reasons that Chairman Powell mentioned the idea of slowing QT going forward.
If the Fed sticks to this process, I expect slower growth but we won’t stall. And many bull markets can exist quite nicely within a 2% GDP growth rate.
So, if I can add to your wonky economics dashboard – pay attention to M2.
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