Does Money Matter?

Money, so they say,
Is the root of all evil today.

-- Pink Floyd

Indeed, one would need to have spent entirely too much time on the dark side of the moon to question whether money supply, in some way, shape, manner or form, influences the economy. The question of how those influences occur, and to what extent, can ignite the closest thing to a barroom brawl among practitioners of the dismal science.

I'll leave the theological debates to others. The issue of whether we're stumbling into a stealth tightening, either through the actions of our good friends at the Federal Reserve or through our own slack credit demand, is one that has garnered an unusual amount of attention of late. Let's try to piece together some answers and then take a look back over the past quarter-century or so to see whether changes in the money supply have affected those things we hold near and dear, principally our own personal money supply.

Measuring Money

Money is devilishly difficult to define, as it is bound inextricably to credit. Most of us remember from our long-ago economics classes that banks can create money within a fractional reserve system. If the reserve requirement, or the amount banks cannot lend, is 10%, an initial $1 billion deposit can be re-lent ad infinitum to a maximum equilibrium quantity of $1 billion / 10%, or $10 billion. Eurodollar and other offshore banking deposits do not have a reserve requirement.

All of this was well and good during the era when banks and banks alone handled banking functions. This has not been the case since the growth of markets such as that for commercial paper, where large corporate borrowers borrow directly in capital markets, or since asset securitization took debt off of banks' books. The 1980 Depository Institution Deregulation Act recognized these changes and others like them. Finally, many consumers have lines of credit through home equity and asset-management accounts.