Inflation tip: watch money supply

Half-joking, McCallum says the twice-a-year sessions of SOMC economists "are not so much fun" because Fed policymaking has "improved tremendously." In the past, monetarist economists often charged the Fed with worsening booms and busts in the economy by its policies.

Now, when the St. Louis branch of the Fed issues its monthly Web publication, Monetary Trends, any sharp, long-term changes in money supply growth are hard to detect in the charts and tables. Such changes might presage worse inflation or a recession ahead.

"It appears interest [in the publication] has gone up some," says a Fed economist.

Yet the Fed itself again manages monetary policy, not by managing money supply, but by buying or selling financial assets in the markets to fix a short-term interest rate on overnight, interbank loans, the Federal Funds rate.

Last month, the Fed pushed up that rate to 5 percent. Economists are debating whether the Fed will shove it up another 0.25 percent later this month in the latest preemptive move against inflation, or leave it alone because of signs the economy is slowing.

Mr. Kaufman holds that the financial markets have too much liquidity. Thus the Fed will have to "make things tighter than generally expected" by eventually hiking the Fed Funds rate to 6 percent.

Such a high rate could hit the stock, bond, and housing markets.

Contrariwise, economists at Goldman Sachs, a major investment bank, see the current "core" inflation rate (a measure that ignores energy and farm prices) as "less than meets the eye." So they figure the Fed will pause in raising interest rates when its policymakers meet June 29.

The Fed and most private economists in the United States stopped obsessing over money-supply figures in the 1980s when innovations in the financial system became so great that money-growth numbers proved to be no longer a good short-term economic predictor. Financial markets became globalized. New instruments of credit multiplied. Money substitutes, such as credit or debit cards and home-equity loans boomed. "The meaning of money has been blurred," says Kaufman.

A basic measure of money called M-1, that includes currency in circulation plus demand deposits in commercial banks, no longer adequately covers total purchasing power in the nation.

Indeed, the St. Louis Fed, regarded as a center for monetarist-inclined economics, now looks more seriously at money supply figures only every half year.

A recent study by William Dewald, a retired Fed monetary expert, does find that money growth relates over the longer term - say, five years - to changes in real and nominal output of goods and services, and to inflation.

So, money still makes the world go round - but with a more substantial lag.

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