This analysis will be split into four parts; the first will concern the Q3 2011 – Q4 2014 period wherein stability in the money gap and nominal spending growth is concurrent; the second, an analysis of the Q1 2015 to Q3 2017 period wherein the money gap shows a sustained albeit slight decline (though still within the range of ideal money gap values), in part concurrent with declining nominal spending growth before the latter’s steady rise starting in Q3 2016; the third, an analysis of the Q3 2017 – Q4 2018 period, marked by a sustained decrease in the money gap preceding steadily declining nominal spending growth; and the fourth, prospects for the coming months in light of the sudden positive trend in the money gap.
Period 1: Q3 2011 – Q4 2014 – The first noteworthy period is the Q1 2011 – Q4 2014 period. Here we see recovery in broad money growth following the crisis, illustrated by a rapid increase in the money gap from a -7.26% decline in Q1 2011 to -1.16% growth in Q1 2012. This is likely accounted for by the US Federal Reserve’s purchases of long-dated treasury bonds and securities from non-bank agents over the period.[1] The money gap then remained relatively stable around values of -1 to 1% for the rest of the period. Nominal spending growth featured a similar stability in its trend, remaining within a 3 – 5% range for the whole of the period. It seems then that this period represents the relatively straightforward relationship between low and stable values of the money gap and stability in nominal spending growth over the mid-term.
Period 2: Q1 2015 – Q3 2017 – We see in this period at first a slight decline in the money gap, from 0.38% in Q1 2015 to 0.28% in Q4 2015, before going on a deeper and sustained decline to -1.63% in Q3 2017. This is consistent with a change in the Fed’s policies: in Q4 2015, the Fed had decided to raise the target rate for the fed funds rate from 0.25% to 0.5%.[2] It raised the rate again in Q4 2016, from 0.5% to 0.75%,[3] and then again over the first half of 2017 to 1%.[4] The tightening of monetary policy, therefore, is concurrent and likely causal in the decrease of the money gap throughout the period. Nominal spending growth had started to decline shortly following the initial decline in the money gap, from 4.77% in Q2 2015 to 2.46% in Q1 2016, but faced a steady rise from thereon, reaching 4.36% by Q3 2017. As this rise does not appear to be explained by the behaviour of the money gap, it is left to an analysis of short-term and real factors.
Three trends in real factors are of note. The first concerns changes in gross fixed capital formation; from Q4 2016 to Q4 2017 it had increased from 1.83% to 5.65%, signalling a rather rapid increase in domestic investment.[5] Growth in net exports increased to an even greater magnitude from -0.16% to 11.11% over the Q4 2016 – Q4 2017 period. By far the most severe change in real factors comes in the form of the increase in changes in inventories, with the rate of change of changes in inventories increasing from -77.52% in Q4 2016 to -11.94% in Q4 2017.[6]
Period 3 Q4 2017 – Q2 2019 – Analysis of this period may be split into two parts. The first concerns the brief spell of increase in the money gap from Q3 – Q4 2017, followed by a sustained decline for the next four quarters, from -0.17% in Q4 2017 to -1.88% in Q4 2018.[7] We see the effects of this excessive decline in the money gap shortly after manifesting in a sustained decline nominal spending growth from 5.75% in Q1 2018 to 4.26% in Q2 2019.
As for the second, what is truly of note over this period is the direction of the trend of the money gap. As of Q2 2019 the money gap is at -0.61%, having increased from -1.88% in Q4 2018.[8] We argue that should this increasing trend be sustained, its effects will manifest as an increasing trend in nominal spending growth in the coming months – a reversal of the declining trend that was a consequence of the sustained decline in the money gap roughly a year previous.
Prospects for Prices and Spending Growth in 2020 – What counts as excessive or too little money growth is indicated by sustained money gap values above 1% or below -1%, respectively; an excessive and sustained rate of money growth would manifest as inflation in asset prices first, and eventually, inflation in goods services prices as well as output growth being unsustainable and above trend. We argue that there has been a striking case of nominal spending growth stability concurrent with the stability of the money gap within 1% to -1% range for much of the period, inclusive of recent months. As such, if the increasing trend of the money gap is sustained over the coming months, so long as it remains within the range of stability as it does currently, there will be a reversal of the declining trend in nominal spending growth but little onset of inflation.
[1] In the Fed’s July 2011 Monetary Policy Testimony, it is stated: “In June, we completed the planned purchases of $600 billion in longer-term Treasury securities that the Committee initiated in November.” In its February 2013 Testimony, it is stated: “Last September the FOMC announced that it would purchase agency mortgage-backed securities at a pace of $40 billion per month, and in December the Committee stated that, in addition, beginning in January it would purchase longer-term Treasury securities at an initial pace of $45 billion per month.”
[2] In the Fed’s February 2016 Testimony, it is stated: “In December, the Committee judged that these two criteria had been satisfied and decided to raise the target range for the federal funds rate 1/4 percentage point, to between 1/4 and 1/2 percent.”
[3] In the Fed’s February 2017 Testimony, it is stated: “At its December meeting, the Committee raised the target range for the federal funds rate by 1/4 percentage point, to 1/2 to 3/4 percent.”
[4] In the Fed’s July 2017 Testimony, it is stated: “Specifically, the FOMC raised the target range for the federal funds rate by 1/4 percentage point at both its March and June meetings, bringing the target to a range of 1 to 1-1/4 percent.”
[5] This might be attributable to the anticipations brought about by Trump’s campaign proposals to cut taxes for all income groups, as well as cutting corporate taxes from 35% to 15% and providing a ‘tax holiday’ to incentivize corporations into investing domestically rather than abroad.
[6] As business stock up during times of uncertainty, this might be attributable to a) Fed target funds rate hikes from 0.25% to 1% over the period, and b) Trump’s winning of the 2016 election.
[7] The decline is very likely explained by the Fed’s reduction in their asset holdings over the period, reducing the broad quantity of money. As per their Feb. 2018 Testimony: “In October we initiated a balance sheet normalization program to gradually reduce the Federal Reserve’s securities holdings. That program has been proceeding smoothly.” And their February 2019 Testimony: “The Federal Reserve’s total assets declined about $310 billion since the middle of last year and currently stand at close to $4.0 trillion. Relative to their peak level in 2014, banks’ reserve balances with the Federal Reserve have declined by around $1.2 trillion, a drop of more than 40 percent.”
[8] This may be attributable to the halting of the Fed’s interest rate increases in early 2019 (indeed, a cut in the Fed funds rate of 25 base points having been announced on the 31st of July), the termination of the asset run-off in August, and the easing of the Dodd-Frank rules prompting increases in lending by commercial banks.