New Fed focus on money supply might aid inflation thinking at the margins

• M2 growth hit a record 27% in early 2021, more than a year before the Fed began raising rates to combat inflation that reached 7.2%; current M2 growth stands at 5.6% as of May while inflation remains at 4.1%, double the Fed's 2% target
• Former Fed officials like James Bullard support monitoring money supply for 'really serious' movements in either direction, and Deutsche Bank found excess money supply positively correlated with inflation during periods of fast growth
• Critics including former Fed staffers argue M2 was removed from consideration 'for good reason' as it has not been a reliable inflation predictor for decades, and much pandemic-era money creation remained as bank reserves rather than entering the broader money supply

Summary

Federal Reserve Chair Kevin Warsh is reintroducing money supply metrics, specifically M2, into Fed policy deliberations after a decade-long absence. While not embracing full monetarism, Warsh believes monitoring money supply can help identify longer-term inflation trends and should be part of a "mosaic of information" for policymakers.

Key Data Points:

• M2 growth peaked at 27% year-over-year in early 2021, well before the Fed began raising rates
• Current M2 growth stands at 5.6% (May reading), approximately 1.2 percentage points below its 1960 average
• Current Fed inflation measure: 4.1% (May), double the 2% target
• Inflation previously reached 7.2% before Fed intervention

Main Argument:

Warsh contends that closer attention to money supply during the COVID-19 pandemic's massive stimulus response could have helped officials better anticipate the subsequent inflation surge. The metric was reintroduced in the Fed's July monetary policy report as an analytical tool rather than a primary policy driver.

Market and Expert Views:

Former St. Louis Fed President James Bullard and Deutsche Bank economists support using M2 as a supplementary indicator, particularly during periods of extreme money growth. Even former uber-dove Stephen Miran has shifted toward a more hawkish stance, suggesting tighter policy may be warranted if money growth accelerates.

Skepticism Remains:

Critics including Wrightson ICAP and former Fed staffers argue traditional monetary aggregates have proven unreliable for decades. Some attribute post-pandemic inflation more to fiscal policy (direct household payments) than monetary expansion, noting much Fed-created money remained as bank reserves rather than entering circulation.

The consensus: M2 may provide marginal analytical value but will remain peripheral to core policy decisions.