THE FED´S MONETARY MYOPIA : MONEY VERSUS CREDIT / THE FINANCIAL TIMES LEX ( RECOMMENDED READING )

Money versus credit

Published: August 11 2009 09:34

The Federal Reserve has little time for money. Not dismissive of the contents of your wallet, per se, the US central bank sees limited value in measures of money as economic indicators. The Fed stopped tracking the broadest measure of US money in 2006, arguing it had not been used in interest rate decisions for some time. Now, it brands its response to the economic crisis “credit easing”, reflecting its focus on the asset side of banks’ balance sheets, rather than “quantitative easing”, a term usually understood to involve boosting the money supply.

This is unfortunate. By its preferred measure of success, the Fed is having a shocker. Outstanding consumer credit has been contracting for five months straight, falling $10.3bn from May to June, down 4.9 per cent on an annual basis. Credit throughout the US economy is flat-lining or in decline, as banks tighten up their lending standards and over-burdened businesses and households begin to pay down debt accumulated during the boom.

Turn to money, however, and the effect of the Fed’s policies is clear. Analysis by Lombard Street Research shows that, while private, non-financial sector credit in the US is contracting, broad money growth began to accelerate early this year. (The European Central Bank, meanwhile, which does pay attention to the money supply, has yet to produce a comparable uptick.) Fed purchases of financial assets from the private sector provide companies and households with additional funds. Instead of splurging, however, they are (quite reasonably) paying down debt.

There is a danger in the Fed’s monetary myopia. Despite much discussion about the Fed’s exit strategy, the really tricky part of extricating oneself from extraordinary policies is not the how, but the when. Focusing on indicators proving slow to respond to its economic massaging increases the chances that the Fed continues the treatment for too long. Healthy growth in broad money can quickly feed through to credit expansion as deleveraging runs its course. Then mo’ money really could create mo’ problems.

Copyright The Financial Times Limited 2009