Despite a continued decline in real money, the excess from past stimulus is still buffering the economy, but continued contraction will push tightening effects deeper into the business cycle.
If inflation is 10% but nominal money increases 5%, there is less "real" money available and when the goal is to measure unit volumes - a real concept - you must adjust nominal aggregates for inflation.
Can the economy produce more cars, more homes, more employment...this is what we are ultimately solving for.
#1 “there was a time when monetary policy aggregates were important determinants of inflation and that has not been the case for a long time”
#2 “Inflation is not a problem for this time as near as I can figure. Right now, M2 [money supply] does not really have important implications. It is something we have to unlearn.”
#3 “the correlation between different aggregates [like] M2 and inflation is just very, very low”.
Banks don't lend deposits. Deposits are the result of lending/investing. All monetary savings originate within the system, DDs are just shifted into TDs. But all bank-held savings are lost to both consumption and investment. That's the error in macro.
GDPnow on 7/25 is @ 2.4%. M2 is growing at a 5 percent rate. But that masks the composition of the money stock. Means-of-payment money is growing at a 9 percent clip. The FED is not tight.
If you reduce policy rates lower than NIMs then bank credit will accelerate.
I want to use tms2 which excludes gov money market mutual funds?? This is a massive component of the money supply right now as people are parking cash in these instruments due to short term treasury rates being so high right now. It only takes 24 hours to liquidate them ro cash so why exclude them?? I think this is a mistake and is skewing your data. M2 is actually up 5% YOY.
The fact that people are accepting short-term rates over investing in the economy is a clear case that interest rates are crowding out private investment.
Nominal M2 is up 4.5% Y/Y. I am using real. Real M2 is up 2% Y/Y and this is mostly driven by a preference for MMF.
If a MMF moves to a deposit, that would be captured in TMS-2.
Thanks for your reply. I agree that short rates/ mmf's are keeping money out of the broader economy due to their high rates.
Isn't the argument about whether or not money supply is growing or not though? This is largely a function of the extent that bank lending is occurring (not how/where people are choosing to save their money).
My calculations show that M2 is in fact growing (although at a somewhat muted pace) therefore we're no longer in a restricted environment. Whether people decide to save their money in MMFs is kind of irrelevant.
No this is about using money supply (real) as a forward looking indicator of real economic growth and employment - particularly in the cyclical sectors of construction and manufacturing. This makes the preference of MMF over deposits very important.
Gotcha. So because people are choosing to park their money in mmf's they are therefore not spending that money into the economy which will lead to economic slowing. So TMS2 is being used to represent this possible phenomenon.
This will obviously change dramatically though as soon as the Fed begins cutting rates as these mmf's (unlike CDs) can be liquidated in 24 hrs. So i'm just not that worried that the liquidity won't be there if/when the economy needs it. This is why I still like to look at M2.
What's important to understand is that the movement from bank cds to MMMFs increases the supply of loanable funds, but not the supply of money. So, the growth of MMMFs has lowered interest rates.
“The definition of M2 includes money market securities, mutual funds, and other time deposits. However, an investment in a mutual fund is in fact an investment in various money market instruments. The quantity of money is not altered as a result of this investment; the ownership of money has only changed temporarily. Hence, including mutual funds as part of M2 results in the double counting of money.”
Actually, the distributed lag effect for money flows, the volume and velocity of means-of-payment money, have been mathematical constants for greater than 100 years.
But Powell destroyed deposit classifications and eliminated legal reserves. We are now operating without a rudder or an anchor.
I don't know about this. This indicator seems to be a weak one. I think the diff between long term rate vs short term rate is a much better indicator. I am not sure why this is, my guess would be because of shadow banking, no one knows how much money they are creating and destroying, still they are affected by rates in the similar way any bank is. Also I think looking at M2 is enough, M2 predicted 1970s and 1980s inflation, it also predicted 2021/2022 inflation. Still M2 is not a good indicator for predicting recessions, this may also be due to shadow banks. It was the shadow banks that caused most of the 2008 collapse.
The yield curve is another component of the Leading Economy basket, in addition to real money supply.
By making the case that M2 is enough but TMS-2 is not, you are saying the difference between them is the important variable (bank CDs and money market funds).
If you plot bank CDs and money market funds, you'll find these are the least predictive components of M2 so by removing them we improve the M2 measure. This is proven empirically.
Also, in the post, we outline the trend in real TMS-2 and it can be seen clearly contracting ahead of all modern recessions.
No I am not saying that TMS-2 is not enough, I am saying both M2 and TMS-2 are very limited in information they give. They can predict inflation really good, but predicating a downturn, they are really limited there. Also it feels like M2 is a secondary indicator and yield curve is primary indicator, meaning yield curve drives M2.
Right, everything has changed though since the GFC though no? Now that the Fed pays interest on reserves, doesn't this naturally drive more money into gov mmf's?
Gov mmfs have grown dramatically as a proportion of M2 making them a much more formidable factor now.
As of December 2008, government money market mutual fund (MMF) assets were about $1.45 trillion.
As of July 2025, gov MMF assets are approximately $5.75 trillion. Making gov mmfs 27% of current M2. This is substantial. Making gov mmfs much more difficult to ignore.
George: "For nearly a century the progress of macroeconomics has been stalled by a single error, an error so silly that generations to come will scarcely believe that it could have persisted for as long as it has done. It is an error that has been committed by John Maynard Keynes and Milton Friedman, John Hicks and James Tobin, Franco Modigliani and Ludwig von Mises, Murray Rothbard and Paul Krugman, and continues to be taught to every economics undergraduate today.
The error has blinded economists so that, like the seven men of Hindostan, they have mistaken the partial reality that has come within their groping grasp for the whole of reality. And this in turn has divided them into warring sects, looking very little like practitioners of a science and a lot like religious fundamentalists. Keynesian has poked fun at monetarist. Monetarist has ridiculed Keynesian. And both have mocked Austrian and been mocked in return.
Thanks to the error Keynesians have been unable to appreciate the importance of money, monetarists have arrived at a wholly misconceived notion of money, and Austrian economists, although they have occasionally stumbled towards the truth, have fallen far short of it..."
No they do not have to borrow from anyone. Example: They can use investment money and borrow it to a company A, as company A is starved for cash. Company A promises to return the money within a month with interest. M2 has not changed though investors think they have money they can withdraw at any time from money market fund, this creates a feeling there is more money than there actually is and if company A defaults, there is a large problem..
What's the justification for using real vs. nominal variables?
If inflation is 10% but nominal money increases 5%, there is less "real" money available and when the goal is to measure unit volumes - a real concept - you must adjust nominal aggregates for inflation.
Can the economy produce more cars, more homes, more employment...this is what we are ultimately solving for.
Fascinating
Thanks, David! Glad you liked it!
This is why EPB research is important:
Powell:
#1 “there was a time when monetary policy aggregates were important determinants of inflation and that has not been the case for a long time”
#2 “Inflation is not a problem for this time as near as I can figure. Right now, M2 [money supply] does not really have important implications. It is something we have to unlearn.”
#3 “the correlation between different aggregates [like] M2 and inflation is just very, very low”.
Banks don't lend deposits. Deposits are the result of lending/investing. All monetary savings originate within the system, DDs are just shifted into TDs. But all bank-held savings are lost to both consumption and investment. That's the error in macro.
GDPnow on 7/25 is @ 2.4%. M2 is growing at a 5 percent rate. But that masks the composition of the money stock. Means-of-payment money is growing at a 9 percent clip. The FED is not tight.
If you reduce policy rates lower than NIMs then bank credit will accelerate.
Great piece! Thanks Eric!
Michael Howell argues that liquidity via credit is what matters
But credit often requires collateral
Quality collateral
I think this is why the banking cartels are so desperate to subjugate Russia
45 trillion USD in collateral there in terms of natural resources
Basically the western banking cartels are starved for quality collateral
All of our stock valuations like for Tesla are ridiculous
There is no there there
A Giant Ponzi scheme
This analysis has one gigantic error. It doesn't follow Friedman's and Swartz's research.
I want to use tms2 which excludes gov money market mutual funds?? This is a massive component of the money supply right now as people are parking cash in these instruments due to short term treasury rates being so high right now. It only takes 24 hours to liquidate them ro cash so why exclude them?? I think this is a mistake and is skewing your data. M2 is actually up 5% YOY.
This is precisely the point.
The fact that people are accepting short-term rates over investing in the economy is a clear case that interest rates are crowding out private investment.
Nominal M2 is up 4.5% Y/Y. I am using real. Real M2 is up 2% Y/Y and this is mostly driven by a preference for MMF.
If a MMF moves to a deposit, that would be captured in TMS-2.
Thanks for your reply. I agree that short rates/ mmf's are keeping money out of the broader economy due to their high rates.
Isn't the argument about whether or not money supply is growing or not though? This is largely a function of the extent that bank lending is occurring (not how/where people are choosing to save their money).
My calculations show that M2 is in fact growing (although at a somewhat muted pace) therefore we're no longer in a restricted environment. Whether people decide to save their money in MMFs is kind of irrelevant.
No this is about using money supply (real) as a forward looking indicator of real economic growth and employment - particularly in the cyclical sectors of construction and manufacturing. This makes the preference of MMF over deposits very important.
Gotcha. So because people are choosing to park their money in mmf's they are therefore not spending that money into the economy which will lead to economic slowing. So TMS2 is being used to represent this possible phenomenon.
This will obviously change dramatically though as soon as the Fed begins cutting rates as these mmf's (unlike CDs) can be liquidated in 24 hrs. So i'm just not that worried that the liquidity won't be there if/when the economy needs it. This is why I still like to look at M2.
What's important to understand is that the movement from bank cds to MMMFs increases the supply of loanable funds, but not the supply of money. So, the growth of MMMFs has lowered interest rates.
Spot on. Retail MMMFs should not be included in the money stock. That's just like MSB's deposits from 1913-1980.
Mises has it right:
“The definition of M2 includes money market securities, mutual funds, and other time deposits. However, an investment in a mutual fund is in fact an investment in various money market instruments. The quantity of money is not altered as a result of this investment; the ownership of money has only changed temporarily. Hence, including mutual funds as part of M2 results in the double counting of money.”
Real money may have only contracted for 3 years, but money flows contracted for 4 years prior to the GFC.
Lead/lag times are variable. So is the magnitude of contraction in real money necessary to create a dowturn.
Real money should be used as a sequential indicator rather than a definitive indicator of an imminent downturn.
Declines or contractions in real money should be a clue to look at the next step in the sequence.
Actually, the distributed lag effect for money flows, the volume and velocity of means-of-payment money, have been mathematical constants for greater than 100 years.
But Powell destroyed deposit classifications and eliminated legal reserves. We are now operating without a rudder or an anchor.
I don't know about this. This indicator seems to be a weak one. I think the diff between long term rate vs short term rate is a much better indicator. I am not sure why this is, my guess would be because of shadow banking, no one knows how much money they are creating and destroying, still they are affected by rates in the similar way any bank is. Also I think looking at M2 is enough, M2 predicted 1970s and 1980s inflation, it also predicted 2021/2022 inflation. Still M2 is not a good indicator for predicting recessions, this may also be due to shadow banks. It was the shadow banks that caused most of the 2008 collapse.
The yield curve is another component of the Leading Economy basket, in addition to real money supply.
By making the case that M2 is enough but TMS-2 is not, you are saying the difference between them is the important variable (bank CDs and money market funds).
If you plot bank CDs and money market funds, you'll find these are the least predictive components of M2 so by removing them we improve the M2 measure. This is proven empirically.
Also, in the post, we outline the trend in real TMS-2 and it can be seen clearly contracting ahead of all modern recessions.
No I am not saying that TMS-2 is not enough, I am saying both M2 and TMS-2 are very limited in information they give. They can predict inflation really good, but predicating a downturn, they are really limited there. Also it feels like M2 is a secondary indicator and yield curve is primary indicator, meaning yield curve drives M2.
Right, everything has changed though since the GFC though no? Now that the Fed pays interest on reserves, doesn't this naturally drive more money into gov mmf's?
Gov mmfs have grown dramatically as a proportion of M2 making them a much more formidable factor now.
As of December 2008, government money market mutual fund (MMF) assets were about $1.45 trillion.
As of July 2025, gov MMF assets are approximately $5.75 trillion. Making gov mmfs 27% of current M2. This is substantial. Making gov mmfs much more difficult to ignore.
Dr. Philip George calls this "The Riddle of Money Finally Solved".
George: "For nearly a century the progress of macroeconomics has been stalled by a single error, an error so silly that generations to come will scarcely believe that it could have persisted for as long as it has done. It is an error that has been committed by John Maynard Keynes and Milton Friedman, John Hicks and James Tobin, Franco Modigliani and Ludwig von Mises, Murray Rothbard and Paul Krugman, and continues to be taught to every economics undergraduate today.
The error has blinded economists so that, like the seven men of Hindostan, they have mistaken the partial reality that has come within their groping grasp for the whole of reality. And this in turn has divided them into warring sects, looking very little like practitioners of a science and a lot like religious fundamentalists. Keynesian has poked fun at monetarist. Monetarist has ridiculed Keynesian. And both have mocked Austrian and been mocked in return.
Thanks to the error Keynesians have been unable to appreciate the importance of money, monetarists have arrived at a wholly misconceived notion of money, and Austrian economists, although they have occasionally stumbled towards the truth, have fallen far short of it..."
Also since stock valuations going up that’s a form of collateral for loans
Do shadow banks have to borrow from real banks or retirement funds?
Don’t think they can issue loans creating money from thin air like banks do
Some say private equity borrows from banks to run their scams
No they do not have to borrow from anyone. Example: They can use investment money and borrow it to a company A, as company A is starved for cash. Company A promises to return the money within a month with interest. M2 has not changed though investors think they have money they can withdraw at any time from money market fund, this creates a feeling there is more money than there actually is and if company A defaults, there is a large problem..
Interesting I am frequently harassed by private credit recently
They seem desperate to lend
CLO'S are one of the canaries in the coal mines.