The Money Supply in Times of Crisis

Due to the recent COVID-19 pandemic and social distancing rules, I've had a couple more hours to examine a topic that has piqued my interest since I first covered it in an introductory finance class at Loyola University Chicago; the money supply. During periods of high social disturbance and uncertainty, data shows radical variability throughout the economy. In these times of uncertainty, the tendency of the masses is to gravitate toward cash and extremely liquid assets. Below, I take a look at the categories of the money supply, how the current COIVD-19 pandemic has impacted the money supply thus far, and recurring strategies used by the Fed to limit the radical variability often seen.

As defined by the Federal Reserve (the Fed), "The money supply is the total amount of money -- cash, coins, and balances in back accounts -- in circulation." Furthermore, the Federal Reserve categorizes the money supply into distinct groups, three of which are: M0, M1, and M2 (Since 2006, M3 has not been tracked as it was deemed to not convey additional economic information and M0 only recently has incurred the same fate).

In general, the different categorizations of the money supply (M0, M1, M2) reflect liquidity. M0 (also referred to as the monetary base) only includes notes and coins in circulation throughout the population, M1 adds to that with traveler's checks, demand deposits (think sort of like a checking account, but for financial institutions), and other checkable deposits. M2 takes an even more encapsulating approach and includes savings accounts, money market funds, time deposits less than $100,000 (a deposit at a banking institution that cannot be withdrawn for a certain period of time, i.e. it has a specified date of maturity), and money market deposits accounts. Essentially, the number after "M" and liquidity have an inverse relationship, the higher the number (0,1,2) the lower the liquidity. And as expected, due to each categorization adding tiers onto its predecessor, M2's total dollar amount exceeds both M1 and M0 (all charts utilizing data from Federal Reserve Economic Data (FRED) provided by the St. Louis Fed):

Now that we have a basic understanding of the different categorizations, a relatively intuitive but nevertheless compelling statistic is the impact on M0 and M1 totals following a day, week, etc period of uncertainty. Below, you'll find the largest percentage changes in these two categories between respective dates of measurement (Usually 1/2 weeks - Ex: November 19, 2008 had a 19% increase from the previously reported observation date, November 5, 2008):

In order to provide context for these massive increases, below are the averages for each category (utilizing data since the Federal Reserve began and stopped measuring each respective level):

The 19% M0 jump on November 19th represents an almost 6000% increase as compared to the historical average. During times of trouble, the old saying rings true, "Cash is king", as observed by the massive increases in liquid money categories that provide American consumers cash or an influx of assets that can quickly be liquidated. To provide further context regarding the highest percentage increases:

• November 19, 2008 / 19% - Japan slid into a recession for the first time in seven years on the 17th of November 2008 and on November 20th, the Dow Jones Industrial Average (DJIA) reached its lowest level since 1997.
• October 22, 2008 / 16.3% - Her Majesty's Treasury (HM Treasury) injected $64 billion of new capital-bailout into several financial institutions to avoid a financial sector collapse on October 13th and on October 24th, Bloody Friday in the United States.
• December 17, 2008 / 11.9% - In December, the US had been in a recession for a year, Rod Blagojevich was arrested for a variety of crimes, Bernie Madoff was arrested and charged with securities fraud, and Russia entered a recession.
• September 17, 2001 / 10.7% - 6 days after the tragedy of 9/11, the largest percentage gain in M0 by almost 2x.

Although the monetary base (M0) has stopped being tracked, M1 shows a significant rise on February 3rd, 2020, but levels out with an average of .21% over February and March thus far. The reason behind it? I'm unsure. It could potentially be that the COVID-19 pandemic has brought on a slow panic, with cases rising significantly each day, but not enough to warrant cash and liquid asset runs. Another daunting possibility is the inverse of the above, where most Americans haven't yet realized the severity of COVID-19. It could also be proof of the trust placed in the financial system today - do American's believe more than ever their banks' ability to keep their money safe?

Now that we understand the different categorizations of the money supply and also how M0 and M1 can be impacted during periods of uncertainty, let's finish up with how the Fed is currently treating this crisis. During times of high uncertainty, the Fed usually cuts interest rates (interest rates currently sit at 0%). Why? The Fed stipulates that interest rates of 0% lock in a low cost of borrowing, encouraging people to borrow more and subsequently spend more. On the other hand, rates of 0% can also cause liquidity traps especially on the back of never before (the Great Recession of 2008 being the first) seen strategies like quantitative easing. Due to the unique policy of easing, the Fed's balance sheet assets have grown a towering amount (as an additional interesting tidbit, the Federal Reserve has an annual report where you can see the massive growth in their assets over the years). To make it a bit easier, here's a short video chart that displays that increase:

The enormous uptick since August 2007 is due in large part to the aforementioned monetary policy of quantitative easing. Through 2018/19, the Fed began to sell off some of these assets, but as recently as March 2020 their balance sheet showed a record high with over $4.6 trillion. What does it mean? After seeing the impacts (and the victories) of monetary policy during and after the great recession of 2008, the Fed seems to be initiating a similar policy during COVID-19, hoping for the same success.

To summarize, M0, M1, and M2 are all categories of the current money supply that have an inverse relationship with liquidity. During the current COVID-19 crisis, money supply variability has not been similar to that of previous previous periods of uncertainty; despite the necessary large-scale economic and social distancing precautions implemented by the US government. Data yet to be gathered or released could upend the current trend or demonstrate a newfound belief in the financial sector. Lastly, that after successfully pulling the US economy of out of recession in 2008, the Fed is starting to take the same precautionary steps used during that crisis in an attempt to avoid another economic recession.