Friday, July 6, 2012

A Brief Note on Monetary Policy

Those who are currently complaining that monetary policy is much too loose most often fail to note that the relationship between the monetary base and the money supply has changed dramatically beginning in the last half of 2008.  While the Federal Reserve will face a difficult decision at some point about interest rates and its provision of reserves to the banking system, it is hard to take seriously any analysis that does not take into account the dramatic reduction in the money multiplier.

For evidence of what I am talking about, here is a graph of M2 and the Federal Reserve Bank of St. Louis adjusted monetary base.  The left scale is logarithmic.

FRED Graph

And here is the M1 money multiplier as calculated by the St. Louis Fed using their adjusted monetary base:

FRED Graph

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