Long Term Perspective

Just about every economic indicator has its fifteen minutes of fame. Money supply, released every week by the Federal Reserve, was closely watched in the 1980s. Changes in money supply are supposed to mirror changes in economic growth. The missing link in the relationship is velocity – the rate at which money turns over in the economy. M2 includes currency, checking accounts, money market accounts, and small savings accounts at banks. The relationship between growth in M2 and growth in GDP is not as good as it used to be, but some diehard money supply fans remain, although not necessarily on the FOMC.

Short Term Perspective

M2 growth has actually been edging upward over the past year – from about a 4 percent pace during mid-2005 to a 6.4 percent pace in the third quarter of 2007. While the relationship between money growth and inflation is not exact and changes over the business cycle, the rise in money growth certainly adds to difficulty the Fed will have in balancing economic growth and inflation risks in coming quarters.