Warsh's Monetary Misstep: Thin-Air Credit to the Rescue

At the recent Jackson Hole annual Kansas City barbecue, Federal Reserve Chairman Warsh mentioned that if the Fed had paid more attention to the surge in the M2 money supply in 2021, it might have raised the federal funds rate sooner. This could have potentially moderated the sharp increase in consumer price inflation that ensued.

The author notes that Chairman Warsh almost gets it right by paying attention to the M2 money supply. However, he could do better by observing the behavior of the sum of the monetary base plus securities and loans on the books of depository institutions (broad thin-air credit).

The author believes that the Fed could achieve a steady rate of growth in thin-air credit if they directly set the level of depository institution reserves. This would require some institutional changes, such as eliminating interest payments on reserves and re-introducing reserve requirements.