30 Years of U.S. Money Supply and Interest Rates
Money supply and interest rates are important macroeconomic factors that can change the direction of entire economies.
In the United States, the Federal Reserve, also known as the Fed, uses open market operations to influence these factors and fulfill its “dual mandate” of maximum employment and stable prices.
But how is money supply associated with interest rates?
How Money Supply Affects Interest Rates
Interest rates determine the cost of borrowing money in an economy. The higher the interest rate, the more expensive it is to borrow money, and vice versa.
By the law of supply, when there is less money in the economy, the cost of borrowing money tends to be higher. All else being equal, a decrease in money supply corresponds to higher interest rates, and by contrast, an increase in money supply tends to put downward pressure on interest rates.
Central banks use monetary policy—the macroeconomic policy that manages interest rates and money supply—to improve economic health. However, the nature of the monetary policy differs based on the state of the economy:
- Expansionary Monetary Policy
Expansionary monetary policies aim to stimulate economic growth by increasing the money supply, lowering interest rates, and increasing demand, spending, and investment in the economy.
- Contractionary Monetary Policy
Contractionary policies aim to slow down unsustainable economic growth and inflation by decreasing the money supply, increasing interest rates, and reducing spending while facilitating saving.
Today, the U.S. Fed is employing expansionary monetary policy, with near-zero interest rates and some of the fastest growth rates for M3 money supply ever seen.
But how has the Fed’s monetary policy changed over recent decades?
Economic Booms and Busts in the U.S.
Between 1990 and 2020, the U.S. money supply (M3) increased from around $3 trillion to $19 trillion, a rate that far exceeds that of economic growth.
During this time, the U.S. economy went through major shocks that affected its monetary policy.
The 2001 Recession
Internet and tech-based companies came to dominate the U.S. economy by the end of the 1990s.
During the same period, the Fed eased its monetary policy, with the goal of reducing interest rates and increasing liquidity in the economy. Excess money supply also went into the stock market, propelling the NASDAQ index to new highs at the time.
To curtail rising inflationary pressures and an overheating stock market, the Fed raised its Fed funds rate target six times between June 1999 and May 2000, reducing money supply growth. This, in turn, slowed down the flow of capital into the stock market in the lead-up to the dot-com crash and the recession that followed.
The 2008 Financial Crisis
The 2008 recession was the most severe economic downturn in the U.S. since World War II.
In an effort to spur the economy out of recession, the Fed dropped its rate target from 3.5% in January of 2008 to near-zero rates by the end of the year. Additionally, it also started a series of large-scale asset purchase programs (also known as quantitative easing), accelerating money supply in the economy.
From the end of 2008 to 2015, the Federal Open Market Committee (FOMC) established near-zero targets for the Fed funds rate in order to support economic activity and job creation.
The 2020 Recession
The pandemic-induced recession of 2020 called for policymakers and central banks around the world to take action.
In response to the financial turmoil, the FOMC dropped its Fed funds rate target by 1.5 percentage points to a range of 0% to 0.25%. It expects these near-zero interest rates to stay until 2023. Furthermore, at the end of 2020, M3 money supply was up by almost 25% year-over-year, the largest yearly increase since 1961.
The Fed’s response to economic turmoil involves large changes in money supply and the Fed funds rate, which affects not only the short term but also the long-term direction of the economy.
The Future of U.S. Money and Interest Rates
An economy’s money supply has a strong association with the currency’s purchasing power and inflation, although there are other factors at play. As the number of dollars in the economy increases, the amount of goods and services that can be bought with one dollar falls as price levels rise.
Due to the policy response during the pandemic, inflation has become a growing concern for investors and consumers alike. With money supply at unprecedented highs and interest rates near all-time lows, it’ll be interesting to see how long it takes for the U.S. economy to recover and rates to rise again.
What is the Cost of Europe’s Energy Crisis?
As European gas prices soar, countries are introducing policies to try and curb the energy crisis.
What is the Cost of Europe’s Energy Crisis?
Europe is scrambling to cut its reliance on Russian fossil fuels.
As European gas prices soar eight times their 10-year average, countries are introducing policies to curb the impact of rising prices on households and businesses. These include everything from the cost of living subsidies to wholesale price regulation. Overall, funding for such initiatives has reached $276 billion as of August.
With the continent thrown into uncertainty, the above chart shows allocated funding by country in response to the energy crisis.
The Energy Crisis, In Numbers
Using data from Bruegel, the below table reflects spending on national policies, regulation, and subsidies in response to the energy crisis for select European countries between September 2021 and July 2022. All figures in U.S. dollars.
|Country||Allocated Funding||Percentage of GDP||Household Energy Spending,
|🇨🇿 Czech Republic||$5.9B||2.5%||16.1%|
Source: Bruegel, IMF. Euro and pound sterling exchange rates to U.S. dollar as of August 25, 2022.
Germany is spending over $60 billion to combat rising energy prices. Key measures include a $300 one-off energy allowance for workers, in addition to $147 million in funding for low-income families. Still, energy costs are forecasted to increase by an additional $500 this year for households.
In Italy, workers and pensioners will receive a $200 cost of living bonus. Additional measures, such as tax credits for industries with high energy usage were introduced, including a $800 million fund for the automotive sector.
With energy bills predicted to increase three-fold over the winter, households in the U.K. will receive a $477 subsidy in the winter to help cover electricity costs.
Meanwhile, many Eastern European countries—whose households spend a higher percentage of their income on energy costs— are spending more on the energy crisis as a percentage of GDP. Greece is spending the highest, at 3.7% of GDP.
Energy crisis spending is also extending to massive utility bailouts.
Uniper, a German utility firm, received $15 billion in support, with the government acquiring a 30% stake in the company. It is one of the largest bailouts in the country’s history. Since the initial bailout, Uniper has requested an additional $4 billion in funding.
Not only that, Wien Energie, Austria’s largest energy company, received a €2 billion line of credit as electricity prices have skyrocketed.
Is this the tip of the iceberg? To offset the impact of high gas prices, European ministers are discussing even more tools throughout September in response to a threatening energy crisis.
To reign in the impact of high gas prices on the price of power, European leaders are considering a price ceiling on Russian gas imports and temporary price caps on gas used for generating electricity, among others.
Price caps on renewables and nuclear were also suggested.
Given the depth of the situation, the chief executive of Shell said that the energy crisis in Europe would extend beyond this winter, if not for several years.
The Inflation Factor: How Rising Food and Energy Prices Impact the Economy
From rising inflation to food insecurity, we show why energy price shocks have far-reaching effects on the global economy.
How Rising Food and Energy Prices Impact the Economy
Since Russia’s invasion of Ukraine, the effects of energy supply disruptions are cascading across everything from food prices to electricity to consumer sentiment.
In response to soaring prices, many OECD countries are tapping into their strategic petroleum reserves. In fact, since March, the U.S. has sold a record one million barrels of oil per day from these reserves. This, among other factors, has led gasoline prices to fall more recently—yet deficits could follow into 2023, causing prices to increase.
With data from the World Bank, the above infographic charts energy shocks over the last half century and what this means for the global economy looking ahead.
Energy Price Shocks Since 1979
How does today’s energy price shock compare to previous spikes in real terms?
|U.S.$/bbl Equivalent||Crude Oil||Natural Gas||Coal|
As the above table shows, the annual price of crude oil is forecasted to average $93 per barrel equivalent in 2022. By comparison, during the 2008 and 1979 price shocks, crude oil averaged $127 and $119 per barrel, respectively.
What distinguishes the 2022 energy spike is that prices have soared across all fuels. Where price shocks were more or less isolated in the past, many countries such as Germany and the Netherlands are looking to coal to make up for oil supply disruptions. Meanwhile, European natural gas prices have hit record highs.
Food prices have also spiked. Driven by higher input costs across fuel, chemicals, and fertilizer, agriculture commodity prices are forecasted to rise 18% in 2022. Fertilizer prices alone could increase 70% in part due to Russia’s dominance of the global fertilizer market—exporting more than any country worldwide.
What are 3 Ripple Effects of Rising Energy Prices?
Oil feeds into nearly everything, from food to smartphones. In fact, the price of oil influences as much as 64% of food price movements.
How could energy and food shocks affect the world economy in the near future, and why is a lot riding on the price of oil?
1. Rising Global Inflation
In 2022, inflation became a global phenomenon—impacting 100% of advanced countries and 87% of emerging markets and developing economies analyzed by the World Bank.
|Countries With Inflation Above Target||2019||2020||2021||Apr 2022|
|Emerging Markets and Developing Economies||20%||20%||55%||87%|
Sample includes 31 emerging markets and developing economies and 12 advanced economies
By contrast, roughly two-thirds of advanced economies and just over half of emerging markets experienced inflation above target in 2021.
This has contributed to tighter monetary conditions. The table below shows how rising inflation in the U.S. has corresponded with interest rate hikes since the 1980s:
|Date||Core CPI at Beginning of Cycle||Magnitude of Rate Hikes
Over Course of Tightening Cycle
2023 is an estimate based on market expectations of the level of the Fed Funds rate in mid-2023. U.S. Core CPI for 2023 based on latest data available.
In many cases, when the U.S. has rapidly tightened monetary policy in response to price pressures, emerging markets and developing economies have experienced financial crises amid higher borrowing costs.
2. Slower Global Growth
Energy price shocks could add greater headwinds to global growth prospects:
|Global Growth Scenarios||2021||2022||2023|
|Including Fed tightening||2.6%||2.4%|
|Including Energy price spike||2.2%||1.6%|
|Including China COVID-19||2.1%||1.5%|
Together, price spikes, hawkish monetary policy, and COVID-19 lockdowns in China could negatively impact global growth.
3. Rising Food Insecurity and Social Unrest
Even before the energy price shock of 2022, global food insecurity was increasing due to COVID-19 and mounting inflationary pressures.
|Number of People in Acute Food Insecurity||2020||2021|
|Middle East and North Africa||30M||32M|
|Latin America and the Caribbean||12M||13M|
Sustained food shortages and high food prices could send millions into acute food insecurity.
In addition, high fuel and food prices are often correlated with mass protests, political violence, and riots. While Sri Lanka and Peru have already begun to see heightened riots, Turkey and Egypt are also at risk for social unrest as the cost of living accelerates and food insecurity worsens.
Since World War II, oil price shocks have been a major constraint on economic growth. As the war in Ukraine continues, the outlook for today’s energy market is far from clear as a number of geopolitical factors could sway oil price movements and its corresponding effects.
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