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Economy in Brief

U.S. Liquidity Growth Fell As Interest Rates Rose
by Tom Moeller March 28, 2005

For nearly a year, the Federal Open Market Committee has been targeting a higher level for the Fed funds rate. The latest action lifted the rate to 2.75% versus 1.0% in late June of 2004.

These actions have been geared to slowing the growth of U.S. money & liquidity in order to contain inflationary pressure. Success is evidenced by substantially reduced three-month growth in several monetary aggregates. Growth in narrowly defined money (MZM) was slightly negative in February versus 7.9% growth last June. M2 growth more than halved to 3.3% and growth in adjusted bank reserves fell to 3.3% from 5.9%.

Further evidence of success is noted by "market based" indicators of monetary policy. The slope of the yield curve between Fed funds and the 10 Year Treasury note now is about half its level last June. The foreign exchange value of the US dollar is up 2.0% from its low, though the value against major currencies still is down versus last year. Finally, while industrial commodity prices still are rising, y/y growth including oil has fallen to 5.3% from over 20% last year.

The relationship between money growth and U.S. price inflation has been maligned due to a breakdown during the 1990s. During all of the last thirty years the correlation between annual growth in M2 and the GDP price index two years later has been 62%, but until ten years ago the correlation was over 80%. (These correlations rank high relative to prices' correlation with liquidity or narrow money.)

The Logic of Monetary Policy from Federal Reserve Board Governor Ben S. Bernanke is available here.

Money & Liquidity Feb 3 Mth % (AR) Jan 3 Mth % (AR) Y/Y 2004 2003 2002
MZM -0.2% 2.2% 3.4% 3.9% 7.4% 12.8%
M2 3.3% 4.8% 5.2% 4.5% 6.9% 7.6%
Adjusted Monetary Base 3.3% 0.7% 4.9% 4.8% 6.3% 8.7%
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