Commentary: Rivers Of Cash Won't Swamp The EconomyBy
Is the world awash in money? Certainly it looks that way. In the U.S., M2--a broad measure of the money supply that includes cash, checking accounts, and money-market accounts--is rising at an annual rate of 9%, up from 6% just a year earlier. The money-supply growth in both Britain and Europe has also accelerated sharply over the last year. And even Japan--one of the few countries where money growth has slowed--has recently cut a key interest rate to near zero, with the aim of stimulating money creation and economic growth.
This flood of money has prompted some economists and investors to worry that a surge of excess liquidity may be a precursor of inflation, as traditional thinking suggests. For example, the report accompanying the Feb. 23 congressional testimony by Federal Reserve Chairman Alan Greenspan noted that some members of the Fed's policy-setting committee "have expressed the concern that the unusually rapid growth in the money and debt aggregates in 1998 ...would ultimately lead to an increase in inflation pressures." In his testimony, the Fed chief raised the question of whether it might be necessary to undo partially last fall's interest rate cuts.
But even with rapid money growth around the world, there is little reason to fear a new round of global inflation. With growth slumping in Germany and Britain, and Japan in a near depression, there is plenty of room for these economies to expand without bumping up against capacity constraints. And as long as productivity continues to rise in the U.S., fast money growth will show up as low interest rates and rapid increases in output, rather than higher prices.
Even if Japan and Europe should recover later in 1999, the chances of excess liquidity igniting inflation are slim. First, despite the conventional wisdom, there is a growing acceptance among economists that money supply growth is a poor predictor of future inflation, especially in the developed countries. "The amount of information in the monetary aggregates is essentially zero," argues Frederic S. Mishkin, a professor at Columbia Business School and a former research director of the Federal Reserve Bank of New York.
Indeed, the growth of M2 in the U.S. in large part reflects factors other than a loose monetary policy. For example, the global turmoil in the second half of 1998 led many investors to move some of their assets from stocks into money-market funds, which are counted in M2. Such movements do not fuel inflation.
Moreover, by most measures the Federal Reserve--the most important central bank in the world--is running a restrictive monetary policy. While M2 is expanding rapidly, interest rates, adjusted for inflation, remain quite high. For example, the real federal funds rate--the key interest rate controlled by the Fed--is between 2.5% and 3%, depending on how inflation is measured. By contrast, the historical average for the post-war period is 1.9%.
BUBBLE QUESTION. True, there is the possibility that too much global liquidity could push up stock market values too high in the U.S., much as it did the Japanese market in the late 1980s. However, there are profound differences between the two situations. For one, by contrast with the U.S., Japan's market bubble really was driven by an explosion of its money supply in 1987 and 1988.
The other difference is the nature of the policy response. In 1989, Japan had a soaring stock market and little inflation, much like the U.S. Nevertheless, fears of a market bubble and an overheated economy led the Bank of Japan to boost the discount rate from 2.5% to 6% in just over a year. These increases, coming just in time for a global recession, set the stage for nearly 10 years of sluggish growth. It is difficult to imagine how a little inflation could have done more damage.
So far, Greenspan and the Fed have stayed away from such a destructive policy path. Nevertheless, if M2 keeps rising, and the U.S. economy and markets continue to stay strong, pressures may grow for preemptive action against future inflation or overly-optimistic markets. But no matter how troublesome excessive liquidity seems, in today's economy the alternative may be worse.