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Okay, let's talk about the Fed. Recent Fed governor and White House economic advisor Stephen Miran, now a senior strategist at Hudson Bay Capital, arguing policymakers should pay less attention to backward-looking data and potentially more attention to the money supply. He writes Federal Reserve officials often claim to look at everything. Ironically, in recent years, their data set has excluded measures of monetary growth. So, Stephen joins us now for more.
Stephen, it's good to see you, sir.
Morning. Thanks for having me back.
Hey, welcome back to the program. I read the note that you and the team put out. A fantastic read. I want to say up front before we start this conversation because I think some economists listening to this will say, 'Ah, not money supply. Here we go.' You say in this note, this report that you've put out, that you're not suggesting we should target monetary supply again. That you think there's information that's worth looking at in money supply. So, let's start here. This is something we used to do at the Federal Reserve. You had the quantum of money and the velocity of money.
And because the velocity of money was largely considered to be stable, we could focus on money supply. That changed. And then people stopped focusing on supply. So, let's start there. Why we used to look at it, why we stopped, and why you think it's worth looking at again.
Sure. So, as you point out, there's this school of economics called monetarism, heavily associated with Milton Friedman, who was a mentor for Kevin Warsh and someone who Chairman Warsh invokes frequently. And monetarism is basically the notion that the money supply determines growth in, or leads to, or predicts growth in nominal GDP and real output and in the price level. And so, therefore, by controlling the money supply growth, you can control the growth of nominal GDP. And if inflation seems too high, you can put a damper on money growth and it'll come down. Now, as you point out, that stopped being useful in the '80s and '90s because this velocity of money that enters into the equation, what economists call money demand, started to move around and be volatile. And so, if money demand is moving around at the same time as money supply, then you can sort of see on any supply and demand chart the equilibrium point is going to be jumping around. And so, changes in the money supply no longer serve to be useful in predicting changes in inflation and changes in growth. Now, what we did is we looked at a number of things that Chairman Warsh has written and said over the last 10, 15 years and found that he repeatedly focuses on this as a useful input into predicting inflation and into predicting growth, right? This is not to say we're going back to targeting money growth, but just that it contains information that shouldn't be thrown out. And what we did was to sort of survey the literature. There's been an active frontier of research in this in the last 10 years or so, what I would describe as rescuing monetarism. And the way that it rescues it is to say, 'Hey, this stuff still works. It's just that you weren't measuring money correctly.' And the reason why velocity started whipping around is because of financial innovation. When you introduce new forms of money, sometimes it uses a store of value and not for transactions. And if a money market fund is used as a store of value and not for transactions, then an increase in money supply driven by an increase in a money market fund isn't going to predict GDP growth. And so, what these new forms of measuring money do is they basically weight the different types of money based on how money-like they are, in the same way that a price index will weight housing more than video games because you spend more on housing than on video games. When you do that, the whole theory actually becomes quite usable again and served to predict well the disinflationary pressure after the GFC, which again, people rake these models over the coals because M2 was exploding and yet we were in a deflationary poor growth environment. And there were all these hysterical letters and op-eds about exploding money supply was going to lead to hyperinflation. It didn't materialize and it was egg on the face for monetarists. But, it turns out that if you measure money correctly, you actually would have gotten the post-GFC environment correctly. You would have gotten the post-COVID environment correct, too.
Let's pick up on that, the post-COVID environment, because money did explode. Money supply did explode, rather like what we saw after GFC, but there was a different outcome. Can you just explain why the outcome was different and why it was still useful to look at supply?
So, the money supply exploded after the pandemic as a result of stimulated monetary and fiscal policy, right? There was a combination of rates being at zero for a long period of time, record levels of QE of a Fed balance sheet expansion, and also fiscal expansions, fiscally driven expansions of the money supply. Now, one nice thing about monetarism is it actually doesn't really care what the origin of the expansion of the money supply is. The origin of the expansion could be monetary. It could be a fiscally driven expansion of the money supply, or it could be foreign. You could have a situation in which there's pools of savings abroad that then come and get spent, and that results in increasing money supply. All it tells you is that there's a link between a change in the money supply and outcomes in the economy and outcomes in the price level. And so, therefore, these models did a really good job after the pandemic predicting that inflation would be high and predicting that inflation would be persistent. And when you have that type of situation, it leads you to think, 'Hey, you shouldn't look through supply chain shocks. You shouldn't look through negative supply shocks. And you need to start getting policy into a right place for the inflation mandate.' Right now, you don't see that at all. You see the models saying that money growth is approximately neutral.
If money was part of the Fed calculus, would they have risen rates sooner?
I believe so. And I think it's not just rates. I think it was balance sheet stuff, too. I mean, the Fed after the pandemic, the Fed was buying mortgages even when home prices were up 20% year over year, right? Home prices up 20% year over year, and the Fed is still buying mortgages. They're saying, 'More credit into the housing sector.' And because of the way that the inflation statistics are calculated and again, inflation measurement is an area I spend a lot of time thinking about. The way that we measure housing inflation really filters into the data for years, right? Measured shelter inflation right now is running closer to 3%. Market rents have been running at 1% for about 3 years now. And so, as a result, it takes a really, really long time for shelter inflation to sort of pass for changes in rental markets to pass through completely through the measured inflation data. Measured inflation data today are still closer to 2023-24 than they are present. And so as a result, if you're buying mortgages when home prices are already up 20% year over year, it's very obvious that it's going to be persistent inflation. So I do think that looking at this would have been helpful earlier. I think that looking at it is helpful now. And the fact that these things are neutral now tells you the supply shocks that have been elevating inflation recently are a lot less likely to be persistent than they were in 2021, which tells you the orthodox policy response to a supply shock of looking through it is probably right.
And you've sat on this committee. How difficult will it be to convince the rest of the committee to look at the same things?
So some of them are there in terms of thinking about the supply shocks like that. So if you look at what New York Fed President Williams said a couple days ago, I think it was a couple days ago. He said monetary policy has to be forward-looking, right? Which is the thing that Chairman Powell has also said. The reason you say that is because there are lags with which monetary policy hits the economy. It doesn't hit the economy for 12 to 18 months. To take this back to Milton Friedman again, he had this parable of the fool in the shower. You know, you turn the water temperature in the shower, it takes a minute for the water to get hot, stays cold, you turn it even hotter, and then it finally comes out scalding. And so then you turn it down, but it's still scalding, so you turn it all even more down, and then it comes out freezing. And so you never get it right, right? That's because there are lags with which you change the temperature in the shower and it hits water. Monetary policy is the same.
Long and variable. And President Williams said this, and I think it's correct. Now, there's another approach which means you need to focus on where inflation is going to be 12 to 18 months.
Can I ask you though your opinion, how long and variable you actually think they are given the wealth channel now, how quickly we price this story in financial markets? Has that changed?
I think that there's some evidence. So when we surveyed this literature on monetarism that we covered in the paper. What one of the papers that really set off the reinvigoration of research into monetarism through these divisia aggregates actually found that monetary policy lags had lengthened recently which was surprising to me. So I'm still inclined to go with the consensus of 12 to 18 months. I'm not inclined to change. There's another approach though which I think you should have seen from other members of the committee who basically say something like inflation has been high recently and therefore I expect it to be high in the future. That to me is treating monetary policy like it's momentum trading. I think that that's not for me, that's not enough. I would want to be forward looking. I worry that some of these people are basically buying inflation at the top.
Steve, I haven't seen you since you left the Fed and I was wondering if you could just give us some insight. What was it like in terms of going from the White House to the Fed? You had a very close relationship with the president at the White House. Did he call you when you were at the Fed? Do you still have an ongoing dialogue with him?
I haven't really spoken to the president since I left government. I stopped into the White House to resign, and that was a great experience. I spoke to him when I resigned from CEA as well. I stopped into the White House then. And then I spoke to him a little bit about the chairmanship selection, but I wouldn't say that I had, you know.
