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How M1 Money Supply & Inflation Are Related

How M1 Money Supply & Inflation Are Related

September 26, 2023

Sometimes, a picture tells a thousand words, and this chart of the M1 money supply certainly does just that.

M1 rose rapidly during the pandemic due to an effort to provide stimulus packages to those who suffered financial loss, and even those who didn't, during the lockdowns. M1 is all the money held by the public in currency and on deposit at the bank. M2 includes all of M1 plus all the other assets that can be easily converted into cash, such as CD's, and money market mutual funds.

When you see a chart like this, it’s easy to understand why inflation has been high in the past few years. "Inflation is caused by too much money chasing after too few goods," said Milton Freidman, one of the most decorated economists of the past 50 years. We've experienced a time in which the government was sending out money, but the money wasn't able to be spent due to shutdowns and supply chain issues.  Hence, the rise in M1 and ultimately inflated prices.

But during the past several months, M1 has started to trend lower. It’s falling at the fastest rate since 1930. So what’s happening?1

M1 is rolling over for a variety of reasons, but the primary reason is people are spending the stimulus money they received. Everyday necessities cost much more than they did 3 years ago. The trend of M1 downward is expected to continue.1

I’m glad I’m not a Federal Reserve governor when I see charts like this. They must evaluate many factors when deciding what’s next for interest rates. So, even though I may not always agree with Fed Chair Powell & Crew, I appreciate the enormous challenge of setting monetary policy for the country.

1., March 30, 2023. “US money supply falling at the fastest rate since 1930s.”