Last September I wrote this article for my newsletter in which I introduced my readers to the Irving Fisher’s equation of exchange which reads MV=PT where M= money supply, V= velocity of money, P=price level, and T= quantity of goods and services transacted (real Gross Domestic Product [GDP]).
The thesis of the article was that due to the Federal Government’s extraordinary efforts to stimulate the economy the nation’s money supply has grown rapidly so we need to be cautious of inflationary pressure; and therefore higher interest rates in the future.
In this morning’s WSJ Kelly Evans sets the record straight by arguing that not only is inflationary pressure an immediate concern for our economy but quite the opposite policy makers should continue to look for ways to boost the money supply to avoid deflation.
In the article she uses the “M2” definition of money supply.
The nation’s money stock, known as “M2,” includes physical currency, bank deposits and households’ money-market holdings. The money stock’s growth, which historically averages around 5% a year, has stalled over the past 18 months since the credit crisis intensified in late 2008.
As measured by M2 she has a point. However, in time it is possible that the Fed’s ballooning balance sheet could work it’s way into the M2 measure of money supply. Furthermore, as economic activity picks up we will also see the velocity of money (V) increase along with GDP (T). Therefore, when you look at the equation of exchange that only leads to higher price levels and interest rates. We’ll have to wait to find out.