An overview of the effects of monetary policy in the USA on GDP and inflation, from 1960 to the present day.

% annual growth rate:

  M3 Nominal GDP
1960 – 2022 7.58% 6.45%
1960 – 1970 7.98% 7.08%
1971 – 1980 11.43% 10.30%
1981 – 1990 7.66% 7.66%
1991 - 2000 5.60% 5.57%
2001 - 2010 7.01% 3.90%
2011 - 2020 5.62% 3.47%

Sources: M3 from the Federal Reserve website up to March 2006 and from the Shadow Government Statistics subsequently. Nominal GDP from IMF database, as at September 2023.

The medium-term relationship between money and nominal GDP growth in the USA, 1961-2022

Five-year moving averages of annual % changes, with 1963 being the start of the first five-year period

Comment on monetary trends in the USA

The USA has had a remarkably eventful monetary history, but the link between money and movements in the price level has been a prominent and persistent feature throughout the last 150 years. Periods of deflation (i.e., falling prices) were seen in the 1870s, as the USA sought to resume gold payments after the Civil War, and in the Great Depression of the early 1930s. These deflationary episodes were associated with falls in the quantity of money. By contrast, the major periods of inflation - during the First World War, the Second World War and the 1970s - were all accompanied by unusually high growth of the quantity of money. This connection was emphasized in Friedman and Schwartz' celebrated study A Monetary History of the United States, 1867 - 1960, and the central bank, the Federal Reserve, responded accordingly by adopting a monetary policy which reduced inflation in the 1980s. The table above shows - very clearly - that broad money growth peaked in the 1970s and from then until 2019 has generally been in decline. Indeed, in the last few years before the coronavirus pandemic the annual rate of broad money growth was under 5%, while the increase in nominal GDP was the lowest since the 1930s.

Despite the evidence, the majority of the Fed's economists are suspicious of the monetary theory of national income determination. Much of the trouble has stemmed from uncertainty over the meaning of money. Over the last 25 years or so money-like liabilities has been issued by many financial institutions that, strictly speaking, are not banks. In the Great Recession from 2008 these 'shadow banks' proved far more vulnerable to financial shocks than the fully-regulated banks. A collapse in the level of shadow banks' money-like liabilities - which can easily be overlooked in the recognised money aggregates - was an important factor in creating the crisis.

This lack of interest in money has proven troublesome in the aftermath of the pandemic. M3 growth rose sharply in 2020 as a result of the monetary and fiscal response to the virus, reaching the highest levels ever seen in peacetime. Until the middle of 2021, the Fed's economists nevertheless only foresaw a very modest rise in consumer prices. However, just like previous examples of the behaviour of national income in the wake of previous steep rises in the quantity of money, a much higher increase followed, with inflation rising to a 40-year high of 9.1% in July 2022.  In response, the US Federal Reserve embarked on a period of monetary policy tightening. As at the end of June 2023 the cost of borrowing has now been raised from zero to 4% - 5.25% in barely 18 months and now stands at its highest level since 2007. Broad money growth turned negative on both an annual and annualised quarterly basis at the start of 2023. The last time this happened was in 2009 and strongly suggests that now the huge monetary overhang from 2020 has finally dissipated, the US economy is likely to suffer a serious recession, even though M3 has subsequently turned positive.