International Policy

Is The Fed Undercounting U.S. Money Supply?

One of the most important of all economic indicators is the money supply, which in the United States is controlled by the Federal Reserve. Most economists believe the money supply plays a major role in the level of interest rates, inflation and real growth in the economy.

Currency is an important component of the money supply.

  • According to the Federal Reserve, at the end of 1997 there was $425.5 billion of currency in circulation.

  • Another component of the money supply, including checking accounts and travelers checks, amounted to $650.5 billion.

  • And a broader measure, called M2, which includes the above plus small interest-bearing accounts and money market funds, totaled $4,045.8 billion.

The Federal Reserve assumes all the money ever printed is still in circulation, less only that which has been withdrawn or destroyed. However, when the Fed surveyed banks, businesses and households to find out how much currency was actually circulating, some 80 percent of it had simply disappeared.

According to recent estimates, more than half of all U.S. currency now circulates outside the U.S. (see figure). Since this is mainly a measure of legitimate currency flows going through the banking system, it represents a low-end estimate of foreign holdings of U.S. dollars. It excludes flows through other channels, such as tourists, personal remittances and overseas military bases. More importantly, it excludes flows through illegal activities such as drug dealing.

This suggests the U.S. domestic money supply is much lower than published data indicate. It also might mean that monetary policy is much tighter than the Fed thinks it is and that the historical relationship between growth of the money supply and rate of inflation needs to be reevaluated.

Source: Bruce Bartlett (NCPA Senior Fellow), "Foreign Dollar Holdings and the U.S. Money Supply," Brief Analysis No. 280, September 23, 1998, National Center for Policy Analysis, 12770 Coit Rd., Suite 800, Dallas, Texas 75251, (972) 386-6272.

For text http://www.ncpa.org/ba/ba280.html

 

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