After QE, Whither the Economy?
Jeff Peshut of RealForecasts.com gives an insightful analysis of the likely effect of the termination of the Fed’s QE programs on TMS, the money supply aggregate formulated by Murray Rothbard and myself and regularly calculated by Michael Pollaro.
Peshut shows that the three rounds of QE succeeded in dramatically increasing the growth rate of the money supply. TMS stood at about $5.6 trillion at the beginning of the QE1 in November 2008, growing to $10.5 trillion by the end of September of this year. The average annual increase of TMS was thus over $800 billion during the period of quantitative easing. The year-over-year growth rate of the money supply reached a high of over 16% during QE1, around 15% during QE2, and leveled off at 8% during the “tapering off” period of QE3.
Peshut also has a valuable discussion of the differential impact of QE on base money, composed of currency plus “covered money substitutes” (equal to bank reserves), which is directly controlled by the Fed, and “uncovered money substitutes,” which are the deposits directly created by bank lending.
Peshut foresees the TMS growth rate accelerating in the short term and than decelerating toward zero through 2016, assuming the Fed maintains its current policy stance. I have a slight quibble with this forecast. As of now the Fed is continuing its ultra-easy monetary policy of targeting a zero interest rate, and most Fed officials do not foresee a change in this policy at least until mid-2015. Charles Plosser, the soon to retire President of the Philadelphia Fed recently expressed strong reservations about this policy as the economy continues to pick up steam. According to Plosser:
That [sic] are many indicators that tell us rates are too low. We have been at zero for nearly six years and there is no precedent in history, even when inflation is too low, to have rates at zero when unemployment rates are as low as they are. We are really behaving in a way that is outside historical norms and that should make us nervous.
And I am very nervous. Trying to artificially suppress interest rates at extremely low levels as businesses increase borrowing and asset prices boom–a la the Greenspan Fed–is a recipe for a continued massive expansion of the money supply that raises the prospect of another runaway bubble followed by a financial disaster.