The Federal Reserve’s March money supply numbers paint a clear picture: M2, a measure of the money supply, experienced a significant surge from early 2020 to early 2022, driven by deficit spending that was effectively printed into existence. However, since reaching its peak in April 2022, M2 has declined by nearly $1 trillion, marking the largest seesaw in U.S. monetary history.
This decline in M2 is attributed to several factors. Firstly, the excess growth in M2 has been absorbed by a growing economy, as the demand for goods and services has increased. Secondly, higher interest rates have encouraged the public to hold onto their extra money, reducing the amount of money in circulation.
The question now is not whether inflation will continue to rise, but rather how much further it will decline. The surge in M2 seen during the pandemic, combined with the subsequent decline, has created a unique monetary environment. As the dust settles, it’s likely that inflation will continue to ease, as evidenced by the return of money demand to more normal levels.
To further illustrate the relationship between money supply and inflation, the article includes several charts. Chart 1 shows the historical growth of M2, which surged during the pandemic due to deficit spending. Chart 2 depicts the growth of currency in circulation, indicating a significant increase in money demand during the same period. Chart 3 defines money demand as the percentage of total income held in M2, which is now returning to pre-pandemic levels. Chart 4 compares the year-over-year growth of M2 with the CPI inflation, suggesting a one-year lag between changes in M2 and inflation.
