The Corner

Monetary Policy

The Money Supply Is Growing But Money’s Still Tight

I argued in a recent column that low interest rates, even persistently and very low interest rates, do not necessarily indicate that money is loose. Low interest rates are in principle compatible with money being tight — and in practice they are compatible with money being tight today.

A number of respondents ask how I can justify that characterization given the extraordinary growth in the money supply. They’re right that the money supply is growing. One measure of it increased by 28.5 percent in May alone, compared with 4.6 percent for the previous May. But that increase has to be considered in light of the sharp increase in the demand for money balances. It’s the interplay of the two that determines whether money is loose or tight.

We can calculate the demand for money by looking at its inverse, the velocity of money, the speed with which it travels from person to person. Multiply the supply of money by the velocity, and we get the total amount of spending in the economy. The trajectory of spending has fallen a lot this year. Supply is rising, but it isn’t keeping up with demand.

If you suspect there’s something circular in what I just wrote, you’re right. The velocity of any measure of money just is, by definition, total spending divided by its supply. What I’ve said, then, reduces to the claim that we should care more about whether total spending is growing at a steady rate than about whether the money supply is.

What’s the point, after all, of characterizing the stance of monetary policy as “loose,” “tight,” or “neutral” in the first place? Presumably it’s as a guide to what the policy should be. If for example it is loose by the right criterion, it should be tightened. There is no point to adopting a criterion that treats money as loose any time the money supply grows at all unless you are committed to a policy of keeping the money supply constant. Or for treating an increase in inflation as a sign of loose money unless a constant inflation rate is the proper goal of policy.

But it would be a mistake to adopt either goal. The money supply should change in response to demand. Inflation should fall when productivity rises and vice-versa. There are excellent reasons to think that monetary policy should aim for spending to grow at a steady rate. If it is instead rising at a faster rate than it usually does, as in the late 1970s, then money is too loose. If it is rising at a rate lower than previously expected, it is too tight. That’s where we are now.

Ramesh Ponnuru is a senior editor for National Review, a columnist for Bloomberg Opinion, a visiting fellow at the American Enterprise Institute, and a senior fellow at the National Review Institute.

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