I commented on a previous question that this is probably a better one. Old question

Generally speaking, how has the increase in money supply resulting from the CARES act stimulus package affected the macroeconomic state of the US? Everything I've found to date is "Well, it hasn't, really" which just seems absurd. There's been a 30% increase in the M1 money supply, and a nearly 18% increase in M3. Did it actually just offset the decrease in velocity of the price level equation P=(MV)/Y to "maintain balance"? What if consumer and business confidence skyrockets for X reason next month, thousands of M&A deals go through, homes are bought and sold, etc etc and velocity to 2007 levels by end of year (I know unlikely, just trying to understand implications with an extreme).

If there's simply more background reading I need to do, links are always welcome.

Reference: 30% increase in M1 18% increase in M3

EDIT: This article was published Bloomberg this morning.

Excluding volatile food and fuel costs, the so-called core CPI -- viewed by policy makers as a more reliable gauge of price trends -- rose 0.6% from the prior month, the biggest jump in almost three decades, after a 0.2% increase in June. On an annual basis, core inflation measured 1.6%, a four-month high, following 1.2% in June.

This is more or what I was expecting to see, and while it obviously isn't a direct causal relationship to the stimulus, is it safe to make that connection? If not, why not?

  • $\begingroup$ The question is conflating the fiscal stimulus package with the increase in monetary aggregates. There’s schools of thought that reject Monetarism, and argue that the fiscal policy effects helped prevent a deeper contraction in activity, while the increase in the monetary aggregates implies almost nothing. $\endgroup$ Aug 11, 2020 at 20:35
  • $\begingroup$ Was the $2 trillion dollar stimulus paid for almost exclusively by bonds sold to the Federal Reserve not the reason for the increase in the money supply? It just happened to increase by that amount simultaneously? What are the alternative schools of thought you mention, and on what basis do they reflect reality more accurately than any other monetary theory? $\endgroup$
    – TCooper
    Aug 11, 2020 at 20:44
  • 1
    $\begingroup$ Sigh. I will offer answer. $\endgroup$ Aug 11, 2020 at 20:46

2 Answers 2


I pretty much agree with the answer that Brian provided except for:

As for the effect of monetary aggregates, there are any number of reasons to expect that their changes will have no observable linkage to activity.

This is not a conventional view hold by mainstream economists, although to Brian's credit he points that out by saying:

Nevertheless, some economists still attach significance to monetary aggregates, one of them will have to offer an explanation.

Even though using 'some' as a synonym for mainstream of the profession is a bit strange.

Mainstream View on Significance of Money Supply:

The conventional view is that changes in money supply actually matter for what the inflation is. For example, this holds true for virtually all general equilibrium macro models presented in Advanced Macroeconomics from Romer which is classic graduate macro textbook. You will find the same views expressed in virtually any undergraduate macro textbook as well. However, there are two caveats:

  1. As shown by Krugman (1998) in his influential paper its not just money supply what matters. It is also the expectations of money supply that matters! Any expansion of money supply that is precieved as being only temporary and promptly reversed will have only limited impact on inflation and inflation expectations at the best.
  2. There are certain situations, a prominent example of such situation would be when interest rates are at zero lower bound (ZLB), where inflation becomes unresponsive to money supply. The reason for this is that at zero lower bound peoples willingness to hold cash becomes infinite as money themselves carry implicit zero nominal interest and hence if central bank would try to push for negative interest rates people would just soak up all the extra cash by hoarding it.

However, even despite the above caveats mainstream economists generally do believe that money supply affects inflation because ZLB is not a 'normal'state for an economy to be in - at least not historically. Moreover, also even though peoples expectations of money supply expansion can be fickle and central banks that are know as 'inflation fighters' might initially not have enough credibility in their commitment to permanently increase money supply, this obstacle is very situational and it is agreed by conventional economists that if central bank is really committed to monetary expansion the expectations eventually adjust.

For example, in 2019 the IGM forum- which is arguably the best poll for discovering what top mainstream economists think as it interviews a cross-section of top mainstream economists of diverse political beliefs, gender and age showed that in response to Q: "Countries that borrow in their own currency can finance as much real government spending as they want by creating money?" which is arguably a proxy to whether M matters for inflation, as the biggest problem with increases in M is that it leads to inflation, 26% disagreed, 57% strongly disagreed and 7% had no opinion and once the responses were weighted by confidence 24% disagreed and 76% strongly disagreed.

Furthermore, of course just because mainstream economists claim there is a relationship that does not mean there has to be one - that would be fallacy of arguing from authority, but my point here is to represent the conventional/mainstream view. Of course, mainstream academia is also not a monolith I am sure that there are mainstream economists who might hold different views but I believe it is fair to say that if they exist they are in minority.

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View of the Bank of Canada (BOC) on Money Aggregates:

Furthermore, Brian misrepresents the official view of Canadian central bank presented on their website. However, I do not want to insinuate he does that on purpose because I think he is valuable user and even though I disagree with him here I actually hold him in high regard and I am sure he would never do that purposefully, rather I believe its due to erroneous assumption that absence of the series is evidence for their views on role of money supply which is fallacy.

In fact the same page that Brian provided link to BOC states:

For further discussion of uncertainty as well as the information and analysis used to inform monetary policy decisions at the Bank of Canada, see Jenkins and Longworth1 (2002) and Macklem2 (2002).

Hence the website does not offer all details. Now if you open both of those papers you will see that actually money supply matters:

For example in Macklem, Tiff, "Information and Analysis for Monetary Policy: Coming to a Decision." Bank of Canada Review, Summer 2002: 11-18 we will find:

The economic model used in the staff projection focuses on the links from interest rates to spending by households and firms. Information on various holdings of money and credit provide yet another view of what consumers and firms are doing and planning to do. In order to spend, consumers and firms need money or credit, so the evolution of the monetary and credit aggregates provides clues to spending plans. In practice, these aggregates are also affected by portfolio shifts and other purely financial developments, so, as with other high-frequency indicators, the challenge for the staff is to separate the genuine signals about economic activity and inflation from volatility related to other factors. Regular contact with financial institutions provides useful insight into the particular developments that appear to be affecting the growth of money and credit at the time. Information is also obtained on credit spreads in bond markets and on any changes in the conditions under which banks are lending to businesses and households as indicators of changes in credit quality and availability. The staff in the Bank’s Department of Monetary and Financial Analysis assemble this information to provide an overall view from the financial side of the economy on the outlook for output growth and inflation, as well as on the risks surrounding this outlook. Based on this analysis, they also make a recommendation to the Governing Council on the setting of the target overnight interest rate at the next fixed announcement date.

Next in Jenkins, Paul and David Longworth, "Monetary Policy and Uncertainty."Bank of Canada Review, Summer 2002: 3-10.

Second, it [The BOC] examines data on monetary and credit aggregates, as well as information on credit spreads and overall credit conditions. The purpose is to assess the behaviour of financial intermediaries, the financial conditions of households and of the business sector, and the implications for demand and inflation pressures in the economy.

The emphasis and comments in [] are mine.

Hence unambiguously BOC takes monetary aggregates into account and believes they have some impact on inflation. Or to be more precise it at least shows that they claim to do that (nobody can of course see what is in their heads).

We can only conjecture why BOC does not list money supply separately on the website but mentioned it in the papers. My best guess is that BOC does not list it because money supply is generally less useful for short-term forecasting, certainly not as useful as augmented New Keynesian Philips curve for example (which is based on output gap that is listed there). However, forecasting ability of a aggregate has no implications for underlying relationships. Even nonsense variables can be useful for forecasting because they happen to co-vary with the variable you want to forecast in some way and vice versa - this is well accepted in literature on forecasting.

For example, according to Economic Forecasting and Policy from Carnot, Koen and Tissot certain types of forecasting models are built:

... models are based solely on the statistical properties of the series under consideration, irrespective of any interpretation or causal relationships informed by economic theory...

The authors also state that such models can often provide relatively better forecasts than the structural (i.e. theory/underlying economic relationship based) models. Also you will find this caveat in pretty much any text on forecasting even outside economic profession. Hence whether money supply is used for forecasting or not in itself tells us nothing about what the actual relationship is or whether institution using such forecasts thinks what the actual relationship is (also note forecasting should not be confused with empiricism or statistical estimation of some empirical models).

However, it is actually a common mistake that even many very intelligent people make all the time to assume that if there is some fundamental relationship between two variables they should be good at forecasting or vice versa. Nonetheless, any such assertions are simply just a fallacy and as a consequence one cannot generally judge underlying economic relationship simply from forecasting models central banks/professional forecasters use let alone from the variables they use for forecasting.

  • $\begingroup$ So in 1. of your two caveats, perception is as important as any mathematical relationship. So if you look at the money supply from late 2008 - mid 2010 you can see that while there was a sharp spike in '08, then it tapered down some and hit a 'low point' in Apr 2010. So even while the money supply wasn't reverting to pre-bailout levels it looked good because it was dropping, helping drive business/consumer confidence in the dollar and maintain investments? To oversimplify as much as I can. And we should see a similar process following this increase in M1? $\endgroup$
    – TCooper
    Aug 12, 2020 at 16:37
  • $\begingroup$ What I'm getting from this, and other reading I've been doing these last several months is someone needs to add a perception variable to the price level equation for it match modern mainstream economics. Yay or Nay? $\endgroup$
    – TCooper
    Aug 12, 2020 at 16:40
  • $\begingroup$ @TCooper perceptions are part of mathematical relationship. You can describe people’s expectations completely mathematically (see the paper I linked). I just did not do that because I got a perception that you are undergraduate student/beginner in economics and I don’t want to throw some complex math at you. If we look at 2008-2010 main problem was ZLB. However, some central banks especially ECB and to some degree Fed also had credibility problem. However, I would not link that to consumer/business confidence that is different story altogether rather if we discuss money supply expectations $\endgroup$
    – 1muflon1
    Aug 12, 2020 at 16:43
  • $\begingroup$ Then the story would be that people expected that once crisis will calm down Fed/ECB will quickly change its monetary policy to reverse the money supply expansions by hiking the interest rates for example. If you believe that then your behavior will be different then if you believe that fed will pursue expansionary policy for long time. In the former case you might not change your spending habits much in the latter you would probably do that. Ultimately inflation comes from people chasing too little goods with too much money if people just take new money and put them under bed nothing happens $\endgroup$
    – 1muflon1
    Aug 12, 2020 at 16:47
  • $\begingroup$ @TCooper not sure what you mean by perception variable - modern models already incorporate expectations in them.It is important to not just check how real variables change but also how people perceive them. Also it’s very difficult to just talk about models in general, you can have theoretical models, empirical models, numerical models, forecasting models. The answer would depend on which of these you are interested in. For example in forecasting almost anything goes - if you can establish that waking up with left foot consistently improves out of sample forecasts of inflation it should be in $\endgroup$
    – 1muflon1
    Aug 12, 2020 at 16:54

As currently written, the question text (and not the title) refers to both the fiscal stimulus and the increase in various monetary aggregates. These are two different things.

On the fiscal side, the bulk of the measures were designed to provide bridging income so that firms and households can continue to operate as they did before despite income interruptions due to lockdown. The objective was to prevent a catastrophic collapse due to cascading defaults, which would have been the usual outcome of such a rapid income drop. (E.g., renters stop paying rent, the rental owner cannot meet debt obligations and defaults, this then takes out the bank that provided the mortgage...)

Despite the size of the bump in the fiscal deficit, it is entirely reasonable to expect that activity variables would do their best to track previous trends. That is, fiscal policy is assumed to have worked by the absence of a deeper crisis, but there was no sudden positive surge to growth (other than the mechanical bounce that came from the end of lockdowns).

As for the effect of monetary aggregates, there are any number of reasons to expect that their changes will have no observable linkage to activity in the current context.

  • Empirically, the same thing happened a decade ago when QE policies were implemented (and earlier in Japan). Why is this time different?
  • From a theoretical perspective, not everyone attaches much significance to the $MV=PQ$ relationship. Within the post-Keynesian tradition, money growth is not seen as offering any predictive power; measured money supply numbers are just the outcome of portfolio balance decisions. Velocity is not constant, as can be easily seen by glancing at a time series database.
  • The following article offers an overview of how Quantitative Easing is supposed to function. Note that a major theory is the effect on interest rates, and not the change in the monetary base. Williamson St. Louis Fed article.
  • Nevertheless, some economists still attach significance to monetary aggregates in the current environment, one of them will have to offer an explanation.

Since there is some criticism of points made here, I want to underline that there are few serious economists that expected the change in monetary aggregates would be always linked to inflation. Let us look at neoclassical theory.

  • Although neoclassical models generally did not include a financial sector before the 2008 Financial Crisis, by all accounts, that omission was seen as a mistake. Neoclassical models have tractability issues when faced with the financial sector, but very few serious economists would dispute that wide monetary aggregates are determined by portfolio allocation decisions.
  • Very few economists expect that volatility will disappear from financial markets, and the associated portfolio shifts.
  • Most neoclassical accept that bank reserves that pay interest are fungible with government debt, and so the central bank can set the mix of reserves versus bonds in a largely arbitrary fashion. Various “QE” policies have done exactly that.
  • Since reserve requirements have been abolished in the US, any historical linkage been deposit/loan growth may be severed.
  • Taken together, all the previous points suggest that there is no reason to expect that observed velocity will be constant on any plausible forecast horizon.
  • $\begingroup$ So basically, a judgement call was made and it was decided that an increase in deficit was a favorable outcome to the cascading defaults you mention. That makes sense to me. I'm still lost to where, in general, the total money supply is more or less irrelevant to macroeconomics? Why track it and make decisions based on it then? Why are interest rates correlated to it? The age old question - Why not print $1,000,000 for every US family then? If increasing it causes no inflation... I know that's also absurd and printing money on that level is catastrophic, but where's the line? $\endgroup$
    – TCooper
    Aug 11, 2020 at 21:09
  • $\begingroup$ Also, +1 and thank you for taking the time to answer what I surmise is "the basics" for you. I hope my questions/lack of understanding is seen as pushing for rationale I can comprehend > an attempt to be confrontational. $\endgroup$
    – TCooper
    Aug 11, 2020 at 21:09
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    $\begingroup$ @TCooper Brian probably here refers to MMT where it is irrelevant however virtually all mainstream economists believe that actually M does matter (i.e what Brian calls ‘some economists’). Printing so much money outside special situations such as one in which economy is at zero lower bound would almost certainly be extremely inflationary. The MV=PY is in one way or another integral part to many current mainstream macro models. But also it’s worth noting that there is more nuance to it - expectations of the variables play crucial role as well for example. $\endgroup$
    – 1muflon1
    Aug 11, 2020 at 22:45
  • $\begingroup$ If interest rates are not at zero, it is literally impossible to “print money” in DSGE models. Money holdings are set by the demand for money by the household sector, and so if the central bank follows an interest rate rule like a Taylor Rule - which is standard - then money stock is no longer directly controlled. $\endgroup$ Aug 11, 2020 at 22:48
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    $\begingroup$ @BrianRomanchuk you dont need to be monetarist for believing that M matters for inflation. In fact pure monetarism is no longer even in fashion in mainstream macro. In New Keynesian macro models that are now predominant in mainstream M matters. I personally cant think of any published paper in some mainstream macro journal where M would not in long run have an effect on rate of inflation, outside some special circumstances such as ZLB, and if perchance some exist it would be quite exceptional $\endgroup$
    – 1muflon1
    Aug 11, 2020 at 22:54

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