Friday, February 22, 2008

Here's the Helicopter

Thomas Nugent has an article at NRO titled,"Who's Flying this Helicopter Anyway?" In it he tries to dispute that the Fed has pumped up the money supply:

Now that the Fed has cut the target funds rate from 5.25 to 3 percent — a reaction to fears of an economic slowdown — the critics are out in force. The Fed, they say, has reverted to the easy-money days of the post-Y2K slowdown, when the stage was first set for the mortgage-market meltdown. They also say current Fed policy is inflationary, and to make their point they dust-off a decades-old analogy: Rather than merely tinkering with his various policy levers, they say the Fed chairman is out flying his helicopter, dumping bales of dollars on the economy.

There’s a big problem with this analogy, however. The Fed chair, be it Alan Greenspan prior to 2006 or Ben Bernanke today, has never been granted a pilot’s license.

Economists point to the monetary base as the source of the Fed’s power to increase or decrease the money supply. The monetary base has two components: currency in circulation (i.e., money in peoples’ pockets) and adjusted bank reserves. Thus, if the Fed chair were dropping dollars from on high, the act would be reflected in the statistics. There either would be a rapid expansion in adjusted bank reserves or an increase in currency in circulation.

And yet, today, neither is the case.

He uses charts of the change in the monetary base and M1 and finds no reason to believe the Fed is dropping money on the economy. I beg to differ. The best definition of money available from the Treasury is MZM and that shows a somewhat different picture:

You shouldn't cherry pick your data Mr. Nugent.

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