The Real Money Supply

The real money supply has come up in a few places recently.  One article speculated that real money supply growth hasn’t been very high over the last few years.  Another, oddly, denied that the real money supply decreased during the 1979-1982 period.  Odder still, the article in question claimed that Paul Volcker cured the 1970s inflation by raising the Federal Funds rate.  Somehow he managed to do this without decreasing the money supply. I’m not going to cite sources for these claims because they are patently ridiculous.  Of course, my advantage is that I lived through the 1970s and 1980s.  Nevertheless, here’s the data.  (Click here to download the Excel worksheet.)

Real M2

I use M2 to measure the money supply for several reasons.  First, historical data shows M2 is a better predictor of nominal GDP growth than M1.  (Milton Friedman and Anna Schwartz (1963). A Monetary History of the United States, 1867-1960. National Bureau of Economic Research (sponsor). Princeton University Press, Princeton, NJ.)  Second, the recent redefinition of M1 and M2 has rendered M1 pretty much useless as a measure of purchasing power.

The FRED database at the Federal Reserve Bank of St. Louis offers data on real M2 They use the Consumer Price Index (CPI) to correct M2 for changes in purchasing power.  That way they can create monthly data.  (The alternative, the GDP deflator, is only available quarterly.)

Here’s the level of M2.

Real M2 the real money supply

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And here’s the growth rate. The horizontal orange line is zero growth.

Real M2 growth the real money supply

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First, let’s look at the range around 2020.

Real M2 growth 2020 highlight the real money supply

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Sorry, folks, the peak of that line is about 20% per year growth.  Growth of the real money supply has exploded.

Second, data for the 1980 events could not be clearer.

Real M2 growth 1980 highlight the real money supply

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Most of that era shows negative real M2 growth.

Data says both assertions are wrong.  More pseudo-economists shooting themselves in their feet.

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About Tony Lima

Retired after teaching economics at California State Univ., East Bay (Hayward, CA). Ph.D., economics, Stanford. Also taught MBA finance at the California University of Management and Technology. Occasionally take on a consulting project if it's interesting. Other interests include wine and technology.