Easy Money, Slow Growth

In today’s Wall Street Journal, John Taylor explains why the U.S. recovery has been tepid while money growth has been very rapid. The recovery has set records for its weak pace, while money growth has set records for its rapidity. Taylor supplies some of the numbers.

Taylor continues an argument he made at the November 2012 Cato Monetary conference. It is the Fed’s policy that is causing the anemic recovery. To quote, “while borrowers like near zero interest rates, there is little incentive for lenders to extend credit at that rate.” He analogizes the Fed’s fixing interest rates to a policy of price ceilings on housing rents. Lenders supply less credit at the lower interest rates, as landlords supply less housing services under rent controls.

Taylor also notes that the Fed’s policy interferes with the signaling of the price system. It distorts capital allocation. Any decently trained micro economist would understand this. Why cannot the backers of the Fed’s policy?

In terms of the demand and supply of money, each round of quantitative easing has contributed to volatility in and the flattening of velocity. There is a dynamic between money supply and money demand. That is something that Milton Friedman explained long ago. In times of rapid inflation, fast money growth leads to a decline in money demand. (That is due to price-expectation effects.) Consequently, prices rise faster than the supply of money. Today, because rapid growth in the monetary base is an instrument for holding down interest rates, that growth in supply increases the demand for money. Hence, the record amount of excess reserves in the banking system.

Taylor’s piece answers “Market Monetarists” and all others who think Fed policy is just dandy, and whose only criticism is that Bernanke is a piker. They argue for even more growth in money, not understanding that their cure is the cause of the problem they are trying to solve.

Stock market guru Larry Kudlow is at least honest about Fed policy. Easy money and a “whiff of inflation” are nice stimulants for stocks. Wall Street does just fine, no matter the consequences down the road. Kudlow quotes “Market Monetarists” approvingly.