We’re Headed toward Stagnation—Unless the Fed Reins In Its Money Printing
The US Fed is considering lifting its inflation target above 2 percent in order to revive the economy. Contrary to the accepted practice, the Fed is not expected to raise an alarm if the measured price inflation begins to rise. The US central bank is not expected to counter this increase with a tighter monetary stance as in the past. In fact, the idea is to continue robust monetary pumping until the economic data points toward a strong economy.
According to most experts, when an economy falls into a recession the central bank can pull it out of the slump by pumping money. This way of thinking implies that money pumping can somehow grow the economy. The question is, How is this possible? After all, if money pumping can grow the economy, then why not pump plenty of it to generate massive economic growth? By doing that central banks worldwide could have already created everlasting prosperity on the planet.
For most commentators the arrival of a recession is due to shocks such as the covid-19 that push the economy away from a trajectory of stable economic growth. Shocks weaken the economy, i.e. lower the economic growth, so it is held. As a rule, however, a recession or an economic bust emerges in response to a decline in the growth rate of money supply. Note that a decline in the monetary growth works with a time lag. This means that the effect of past declines in the growth rate of money supply could start asserting their influence after a prolonged period.
It is likely that the present economic slump was set in motion by a strong downtrend in the yearly growth rate of AMS money supply from 14.3 percent in August 2011 to –0.6 percent by August 2019. As a result, various activities that sprang up on the back of the previous strong money growth rate came under pressure. (Observe that the yearly growth rate of AMS jumped from 0.7 percent in March 2007 to 14.3 percent by August 2009.) These activities cannot fund themselves independently. They survive on account of the support that the increase in money supply provides. The increase in money diverts to them real savings from wealth generating activities and consequently weakens wealth generators.
A decline in the growth rate of money supply undermines various false nonproductive activities, and this is what a recession is all about. Recessions, then, are not about a weakening in economic activity as such but about the liquidation of various nonproductive activities that sprang up on the back of the previous increase in money supply.
Irrespective of whether an activity is productive or nonproductive, it must be funded. At any point in time the number and the size of activities that can be undertaken is determined by the available amount of real savings. From this, we can infer that the overall growth rate of productive and nonproductive activities as a whole is set by the growth rate in the pool of real savings. (Individuals, whether in productive or nonproductive activities, must have access to real savings in order to sustain their lives and well-being. Also, note that money cannot sustain individuals but can only fulfill the role of the medium of exchange.)
As long as wealth producers can generate enough real savings to support productive and nonproductive activities, easy money policies will appear to be successful. Over time a situation could, however, emerge where as a result of persistent easy monetary policy and reckless government fiscal policies, there are not enough wealth generators left. (Wealth generators are badly damaged by loose monetary and reckless government policies.) Consequently, real savings are not large enough to support an increase in economic activity.
Source: Frank Shostak | Mises Institute