Edward Lotterman
Crucial topics in economics go in and out like fashion trends.
When I first taught macroecon in the 1980s, the money supply was a key issue in economic policy. Inflation was high. The Keynesian orthodoxy of the 1960s and 1970s, that a central bank like the Federal Reserve should actively raise and lower interest rates to manage the economy, was in disrepute.
And the United States was not the only nation that was experiencing recession at the same time as high inflation.
Monetarists, a philosophical minority group led by Milton Friedman at the University of Chicago, emphasized the role of the money supply in economies and its primacy in determining inflation. Central banks, Friedman argued, needed to shun alternating gas and brake pedals on interest rates. They should instead focus on limiting money growth so that, as output grew, prices would remain stable.
Inflation was a symptom of too much money in the economy, they argued. This incentivized demand, and by extension prices, to go up. So the Fed should crimp down on money growth to end it. The wage and price controls President Richard Nixon had tried were as useless as the faddish WIN (Whip Inflation Now) buttons purveyed by his successor, Gerald Ford.
How things have changed!
The Fed just finished deliberating last week with our nation in the most perilous economic time since the late summer of 2008. Yet one can search in vain for any mention of “money supply” in the current thinking of the Fed. This is especially — and tragically — ironic because the current problems derive largely from the largest peacetime expansion of the money supply in at least a century.
President Jimmy Carter had taken the politically courageous step of appointing Paul Volcker, a pragmatic monetarist, to head the Fed even though advisers warned Carter that the new appointee would follow policies that would doom his reelection.
Volcker convinced the Federal Open Market Committee to crimp money growth and stay the course regardless of what happened to interest rates, output or employment. Some short- and medium-term business and consumer interest rates went to 20%. The federal government had to guarantee 14% for 30 years to sell bonds. Unemployment rose and output fell. High interest rates attracted foreign money, making the dollar “stronger.” That took a pole axe to farming, steel and autos among other sectors that depended on exporting or that competed with imports.
Inflation did fall, although it took years. But people had learned a lesson. At least part of the monetarist creed was correct. Money indeed mattered. Inflation could be avoided or conquered by regulating how much money is out there.
Econ teachers taught even freshman intro students about the money supply in great detail. Here’s what they learned:
In general terms, the money supply is currency — bills and coins in circulation — plus bank deposits that can readily be used to make payments. Measures of money called M1, M2 and M3 were made, depending on which types of deposits — checking, saving, certificates of deposit or even money-market mutual funds — were included. There were even further variations. These were discussed frequently in financial news media. Students had to memorize details before exams.
Then, somehow, in the post-stagflation prosperity of the administrations of George H.W. Bush and Bill Clinton, with low inflation, good GDP growth, very low unemployment and federal budget deficits melting away, we forgot about the money supply.
In the new century, the Alan Greenspan-led Fed responded to the exogenous shock of 9/11 by cutting interest rates. That required increasing the money supply but this detail was not mentioned. The most common measure, M2, was up 6% in a year and 16% in two years after the attack. Remember that folks.
We got into a long national nightmare of war in the Middle East and South Asia. Financial markets throbbed with a panoply of new financial institutions — hedge funds — trading new financial instruments — derivative securities — the values of which were tied to still other financial instruments like home mortgages. Creating and trading these new derivatives became frenzied. As long as underlying residential real estate demand, and prices, went up, these would continue to make money. Then the housing market collapsed. But the derivatives still had to be financed.
After a warning hiccup in very short-term money markets in mid-August 2007, the bust came in 2008. Investment bank Bear Stearns went under in mid-March setting off a panic. When Lehman Brothers faltered badly in October, we teetered on the abyss of a market crash worse than 1929.
The Federal Reserve and the Treasury pulled the nation back from the brink with an enormous bailout they jerry-rigged in ways that stretched the limits of their statutory authority. New Fed- and Treasury-created securities absorbed bad loans and were parked in obscure new funds with names like “Maiden Lane.” Wall Street and the general economy were saved from disaster.
However, many consumers got hosed. Laws regulating home foreclosures went widely unenforced. Vulture funds such as the one led by Donald Trump’s first Treasury secretary Stephen Mnuchin bought up distressed mortgages and robo-processed foreclosures. Household losses created new multimillionaires.
Yet somehow in all this, the term “money supply” got erased from the brains of pundits, journalists and the general public. Mentioning how much money had been created to save us from Wall Street’s financial debacle would have been like discussing distress in the lower tract at a Ladies Aid tea.
In retrospect, the rise was not all that much. M2 rose by 10.3% in the year after Bear Stearns’ downfall and topped out at only a cumulative 17% three years after the panicked Lehman Brothers weekend. Pin those numbers also, folks.
We faced no more big exogenous shocks until COVID hit as 2020 opened. It was the worst global pandemic in a century. The Fed, acting in very good faith and erring on the side of too much rather than too little, pulled out all the stops.
On Jan. 20, 2020, the CDC announced a case in a Washington state nursing home. The Federal Open Market Committee meeting on Jan. 29 of that year does not mention this. But at their March meeting, they dialed the money printing press up to warp speed. By the time President Joe Biden took his oath 12 months to the day after the first COVID announcement, the Fed had already increased the M2 by 25.3%. They kept at it, peaking out at a 40.6% cumulative increase in the money supply 26 months after the first U.S. case.
One must dig deep to find estimates of money supply for World War I and the Civil War, but it is clear that what happened after COVID was unprecedented in the peacetime history of our nation. Yet no mention of it was made in the general media. Nor has it generated much discussion among economists.
And the resulting inflation (enter the monetarists!) largely cost the Biden-Harris-Walz Democrats the 2024 election, sweeping Trump into the Oval Office. With war in Ukraine, it spiked farmland prices to a degree not seen since the run-up to the 1980s farm crisis. And it certainly is a major factor in the bidding up of house prices and financial markets.
Yet it gets no mention at all.
Our economy is in real peril. The Fed faces difficult choices. It had succeeded in slowly letting some air out of the money supply balloon, so that a year ago, M2 was only 34% above the pre-COVID starting point. But to ease its target rates, the Fed had to again create money. So that the figure for March 2025, is 40.7% above five years ago.
Compound that with Trump’s tariffs and we have a real problem. Until this trend enters general discussion, and is remedied, all other policy moves will be crippled.
Related Articles
Real World Economics: GDP is important, but must be kept in context
Real World Economics: The buck stops Trump, or so it appears
Ed Lotterman: What if the Fed set a trap for Trump?
Real World Economics: Powell hits first; Trump hits back
Real World Economics: The Minneapolis Fed was right all along
St. Paul economist and writer Edward Lotterman can be reached at stpaul@edlotterman.com.
Leave a Reply