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The Mercurial Money Supply

Economic Trends


Its recent surge sparks concern

Remember the money supply? Although it hasn't played a part in the Federal Reserve's policy decisions for some years, some economists think that could change in coming months.

For one thing, the Fed has itself observed that the traditional links between money growth and economic activity appear to have reasserted themselves. More important, in a speech at Stanford University in early September, Fed Chairman Alan Greenspan pointedly reminded his audience that "inflation is fundamentally a monetary phenomenon."

That's significant because M2 and M3, the most widely watched monetary aggregates, have not only been above the Fed's target ranges much of this year but have recently accelerated sharply--with M2 rising at a 10.9% annual rate in August and M3 clocking a 12.6% pace.

Over the short run, of course, money growth affects actual economic activity. (That's why real M2 is a component of the index of leading economic indicators.) Indeed, some experts attribute the economy's unexpectedly strong performance over the past year in part to the sharp pickup in monetary growth that began a few years ago (chart).

But over the long run, persistent rapid monetary growth can fuel inflation. And the fact that the money supply continues to surge higher, along with other signs of a still buoyant economy, worries some money-market observers.

"In our view," says Edward S. Hyman Jr. of International Strategy & Investment Group, "excessive money growth is now a significant problem for the Fed. It directly explains the inflation in stock prices and home prices that has unfolded this year." He thinks the money-supply numbers heighten chances of a Fed rate hike before yearend.

Economist Paul Kasriel of Chicago's Northern Trust Co. agrees but notes that "money growth affects prices only after a considerable lag." Since early 1995, he says, M3 has been consistently outpacing the growth of factory capacity--a situation that his analysis indicates tends to lead to a rise in core inflation after a lag of roughly three years.

"It may not be large," he says, "but some pickup in inflation next year is probably unavoidable."BY GENE KORETZReturn to top

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Interest costs may be the key

The consensus view is that the main factor affecting corporate profits in the year ahead will be the pickup in labor costs. Economist Daniel E. Laufenberg of American Express Financial Advisors Inc., however, thinks the experts may be watching the wrong indicator.

Laufenberg notes that the most significant shift in business costs in recent years appears to be in interest expenses rather than labor costs. While corporate profits before taxes rose from less than 8% of national income in early 1990 to about 11% at last count, labor compensation costs have declined by only 1.2% of national income in the same period. But net interest expenses have fallen three percentage points (from nearly 10% to a bit under 7%)--just about as much as profits have grown.

Similarly, Laufenberg points out that the sharp four-percentage-point drop in the profits share of national income in the late 1970s and early 1980s coincided with an almost symmetrical four-percentage-point rise in the net interest share of national income. All of which, he says, suggests that profits growth can still stay relatively strong if interest rates trend lower.Return to top

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