Is Monetarism Making a Stealth Comeback?

Monetarism – the idea that money supply control could be the basis for monetary policy – hit its high-water mark during the first Reagan administration. Nobel Prize winner Milton Friedman famously said that, under monetarism, monetary policy could be run from the basement of the Federal Reserve building by a clerk. The theory has fallen from grace since. Basically, in a global economy with instantaneous capital flows it became difficult to know exactly what the “money supply” is, let alone measure it.

Has there been a stealth return of the importance of money growth, in this case the Fed’s balance sheet? Consider that up until 2019 there was a major reduction of the size of the monetary base. As a result, Treasury yields fell, the dollar strengthened and the yield curve flattened. Since then, the Fed has been adding money to the funding markets. In other words, did monetary contraction outstrip the effects of interest rate cuts? This will bear watching in 2020 – will the FOMC want to return to its original plan to reduce the size of the base, just more slowly? Or will it sit pat – like with its current Fed funds rate stance? Stay tuned.

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