At the time (again, in 2003), Ebeling wrote, "There is nothing in recent Fed monetary policy to suggest that there has been a decline in the supply of money and credit." Indeed, what followed the easy money policy was asset price inflation from the unprecedented housing boom, which culminated in the Panic of 2007 (to use a Fed VP's preferred term). So, where are we today in terms of the supply of money?
While money supply may not be in decline as measured by M2 NSA year-over-year, it has slowed considerably to less than 2%, from over 10% at its recent peak. Prior contractions on this scale have precipitated asset price deflation, most visible in the form of stock market crashes. (Notably, the contraction in money supply in the summer of 2009 did not result in asset price deflation because the Fed's concurrent $1.75 trillion in asset purchases were redirected into risk markets.)
In contrast, after the prior recession in 2001, M2 fluctuated between 6.0% and 8.5% YoY until late 2003, facilitated by the Fed lowering the Federal Funds target rate to 1%. In the present, even other measures of money supply are not broadcasting inflation, as Money Zero Maturity (MZM) is in outright contraction. Some will point to the monetary base (M0) which, at 20% YoY, would appear inflationary. However, it is down from over 100%, and it must be noted that the Fed payment of interest on excess reserves (IOER) keeps $1 trillion of M0 parked at the Fed. Indeed, were the Fed to truly pursue a zero interest rate policy (ZIRP), it would lower the current IOER rate of 0.25% to zero (not recommended, but an interesting though experiment).
As to credit, the Fed has wound down nearly all its temporary liquidity facilities and terminated its quantitative easing programs (except for some limited MBS dollar and coupon roll activity). In addition, it has nominally increased the discount rate, the rate charged to borrow from its primary credit facility, from 0.50% to 0.75%.
From an interbank perspective, the cost of borrowing is rising as evidenced by an increasing Libor-OIS spread, though not nearly to levels reached in the post-Lehman crisis.
In addition, the Federal Funds rate, or the overnight unsecured lending rate between banks and certain other large institutions, has recently been ticking lower.
Though perhaps non-intuitive, a lower Fed Funds rate is indicative of less liquidity because of the structure of this market. The major lenders of Fed Funds are the housing related [quasi] GSEs, Fannie Mae and Freddie Mac. Because they are not banks, they are not eligible to earn interest on money the way banks do with IOER, and must find other ways to invest excess funds short term. According to the Fed, they tend to transact with a few favored banks, such that when fear is increasing, they narrow the scope of lending, and the rate decreases. (It is also normal for end of quarter bank activity to effectively shut down the Fed Funds market, so nothing significant should be inferred from a precipitous drop on the last day of each quarter.)
Finally, consumer credit has been in outright contraction for over a year, for the first time in the post-war period.
Accordingly, from the perspective of the Federal Reserve to banks, banks to banks, and banks to consumers, credit is in decline. And, as has been demonstrated, monetary policy by the Fed, while certainly not hawkish, has been less easy by several measures. While one can concede the Fed will not hesitate to become easy[er] in the future, for the time being, we are experiencing both Price-Wage Rigidity Deflation and Monetary Deflation, per Ebeling's definitions. As he wrote,
"The continuing hubris of the central banker can be seen in his failure to fully appreciate that it has been his own monetary policies that have created the unstable booms and bubbles that he complains about and criticizes. And even when he admits that central bankers have erred in the past and have produced those very consequences to which they object, he continues to believe that “next time” they will get it right."
The danger is that we are in an intervention-induced cycle of decreasing periodicity of both inflation and deflation, with the level of intervention increasing each round and shortening the cycle. The deflationary episodes choke the entire economy, while the subsequent intermittent reflation attempts front-run the necessary resource reallocation, rewarding disproportionately the non-productive sectors. Hence, the zombie economy.
Only when the zombies are buried for good (and they will be by force, if necessary, by the bond vigilantes), will the necessary adjustments be made by pure market forces to allow another era of sustained growth. Barring a collective anagnorisis on the part of the world's central planners, it will likely be the bond vigilantes that reconcile the economy with reality.
