Message In The Money Supply

The Fed may need to clamp down

In a widely reported speech in September, Federal Reserve Chairman Alan Greenspan pointedly noted that "inflation is fundamentally a monetary phenomenon." Small wonder, then, that many economists are casting a wary eye on the latest money-supply numbers.

Not only did M2 and M3, the most closely watched monetary aggregates, exceed the target ranges set by the Fed last year, they have accelerated sharply in the past six months and are both rising at their fastest rates in the current expansion. At last count, M2 was growing at a 7.4% annual pace, while M3 was up at a heady 10.8% clip.

Meanwhile, Greenspan revealed in his recent Humphrey-Hawkins testimony before Congress that the Fed is maintaining last year's maximum growth targets of 5% and 6% for M2 and M3, respectively, in 1998. The fact that the Fed failed to nudge the targets higher suggests that policymakers regard the surging money supply with some concern. Although the Fed has downplayed money as a factor in its policy decisions on the grounds that the relationship between it and economic activity is uncertain, Greenspan's testimony noted that the relationship has recently "come back more into line with historical patterns" and was actually stable last year.

What is undeniable is that both monetary growth and economic growth exceeded the Fed's expectations last year and could well do so again in 1998. Economist Robert E. Mellman of J.P. Morgan & Co. points out that the Fed's quarterly survey of senior bank-loan officers last month not only showed no tightening of lending standards but also indicated that loan demand is now rising on a broad front.

The bankers report that demand for home and commercial mortgages have accelerated sharply, business loans are continuing to rise, and even consumer installment loans are starting to strengthen. While foreign trade is weakening and business investment seems to be slowing, says Mellman, interest-rate-sensitive and credit-driven sectors are taking up the slack.

Like the Fed, Morgan economists tend to see such developments as an offset to a developing sharp economic blow from Asian turmoil. But the rapidity of monetary and credit growth, the upturns in housing, auto sales, and commercial real estate, and the still-buoyant stock market are leading some observers to wonder if domestic demand may prove too strong and the hit from Asia too weak to obviate the need for Fed tightening in the months ahead.

"It's not surprising," says Mellman, "that Greenspan's latest remarks have stressed the Fed's `determination to hold the line on inflation."'

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