In retrospect, it's easy to understand the Federal Reserve's latest decision to forgo a rate hike. Despite low joblessness and a buoyant first quarter, inflation is still dormant. Consumption and industrial output have slowed. Fiscal policy promises to stay restrictive for the foreseeable future. And low-wage workers are seeing real pay increases for the first time in recent memory.
Still, some economists say Greenspan & Co. may be missing the boat by not heeding an old familiar leading indicator: the money supply. Although the Fed has tended to downplay the money supply in its policy decisions for some years, Greenspan noted recently that the links between money and economic activity appear to be stabilizing again.
That's noteworthy, says William V. Sullivan Jr. of Dean Witter Reynolds Inc., because monetary growth could provide an answer to a puzzle plaguing economists: why the economy's growth rate eclipsed expectations by such a wide margin in three of the last four quarters. "It may be no coincidence," he says, "that growth of the M2 and M3 monetary aggregates have been trending higher since mid-1995."
Indeed, economist Paul L. Kasriel of Chicago-based Northern Trust Co. notes that M3 has been growing faster than nominal gross domestic product for nearly two years (chart) after lagging nominal economic growth for eight years. "The last time that happened was in 1986 and 1987," he observes, "and inflation accelerated in 1988 and 1989."
Recent monetary growth remains strong. M2 has climbed at better than a 5% annual pace so far this year, while M3 is currently posting its largest year-over-year advance since 1987. Significantly, growth of both M2 and M3 has been exceeding the target ranges set by the Fed at the start of the year.
Both Sullivan and Kasriel think such vigorous monetary gains foreshadow a pickup in economic activity in coming months--a pickup that could well exceed the Fed's speed limit for noninflationary growth. It's something Alan Greenspan may also be worrying about. In his early May speech in New York, he repeatedly referred to the dangers of "excessive credit creation, spurred by overly accommodative monetary policy."