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Written by Richard M. Ebeling
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Wednesday, 22 April 2009 00:00 |
The Federal Reserve went on an expansionary binge during the last four months of 2008, after the financial crisis began to worsen in September. While the rate of monetary expansion has been slowing in the early months of 2009, it still remains significantly high. Future price inflation remains a growing concern for the second half of 2009 and 2010.
The chart below tracks the growth in three monetary aggregates since the beginning of 2008. All have expanded greatly since last summer.
The monetary base measures currency in circulation and the reserves in the banking system that serve as the basis for bank lending. Between September and December 2008, the monetary base grew by more than 82 percent from $905 billion to well over $1.6 trillion dollars.
The Federal Reserve continued to expand the monetary base through the first week of April 2009; it was about 4.4 percent larger than in December of last year. The rate of expansion in the monetary base has dramatically slowed down compared to September-December. Still, the monetary base stands 90.5 percent above than it was a little over eight months ago.
Two other monetary aggregates have also continued to noticeably expand in size. M-1 measures currency in circulation, and demand and other checkable deposits in the banking system. It has increased by almost 18 percent over the last eight months. But since the end of 2008, M-1 has expanded by a little less than 3 percent.
M-2 includes M-1 plus savings and other small denomination time and related deposits. It has grown by nearly 10 percent since September of last year. As with M-1, M-2 has only expanded by about 3 percent in the first part of 2009.
These other monetary aggregates have not grown in line with the far more dramatic increase in the monetary base largely because banks have been shoring up their cash positions in response to the financial crisis. In addition, the Federal Reserve has been offering a positive rate of interest on excess reserves held by member banks.
Banks are required to hold a certain amount of minimum or required reserves against their outstanding depositor liabilities. Normally if the Federal Reserve expands reserves in the banking system by buying U.S. Treasury securities and other financial assets through open market operations, banks soon lend out the those additional funds created by the Federal Reserve to generate more interest income.
While total reserves in the banking system have grown dramatically, as reflected in the expansion of the monetary base, banks in general have been holding a large portion of these additional funds as excess reserves, i.e., reserves held above their required reserves.
In August 2008, bank excess reserves made up about 4.4 percent of total reserves. In the first week of April 2009, according to the latest Federal Reserve report, excess reserves represented over 93 percent of total reserves in the banking system.
This means that a huge amount of loanable funds are sitting in the banking system that can finance a large amount of future borrowing at some point. This also means that when these funds do start entering the economy in the form of future spending by borrowers, significant price inflation may well be in store for the United States.
Whether this borrowing initially takes the form of increased private sector expenditures or the funding of the Federal government’s exploding deficit spending, all those hundreds of billions of Federal Reserve created dollars will be putting upward pressure on the prices of investments, resources, labor, and consumer items.
The currently lingering fears of price deflation will very likely be transformed in the not too distant future into the reality of rising price inflation.
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