What is money? How much money is out there? Every week, the Federal Reserve publishes it’s current estimate of the Money Supply, how much money is available in the U.S. economy. This estimate includes the total amount of cash, deposits in checking and savings accounts, and easily convertible near money (money market securities, CD’s, etc) that is available in the United States.
For the 25 years prior to the Covid-19 pandemic, the money supply expanded by about 6% per year and inflation averaged a little more than 2% per year. The Federal Reserve’s stated goal for long term inflation is 2% per year, so while inflation was below their goal just prior to the pandemic, the long term inflation rate was ideal.
When the pandemic hit and the economy was forcibly shut down, the spigots were opened and the money supply was increased by 33% in less than 2 years. During the first year of the pandemic, people held on to their cash, their safety net. Now as the economy continues to open up, people are spending (and borrowing) this additional money. This is one of the many factors that has driven inflation to 7.5% for the past year.
So what can be done about it?
There are three ways for the banking system to reduce this oversupply of money. 1) People can pay off their loans. Paying off a loan removes money from the money supply until it is lent out again. 2) The Federal Reserve can take money out of the banking system by selling off some of their bond holdings. This policy decision will be a point of contention at the Federal Reserve for the foreseeable future. 3) Over time, inflation will take care of matters, rebalancing the price of goods to the level of supply/demand.
The Federal Reserve has said that they are going to stop adding extra money to the money supply in March. At some point, they will need to sell some of their bond holdings. Most likely, it will be stubbornly high inflation that absorbs the majority of the increase to the money supply.