Why hasn’t American growth slowed down more when interest rates have been jacked up?
The graph below, which I have created with a little help from data from the Federal Reserve St. Louis’ FRED database, and which I have processed through ChatGPT 4.0, illustrates what has happened.
In 2020-21, the USA implemented massive monetary and fiscal policy easing. Basically, the American government sent money directly to every citizen. These funds were financed by the government issuing treasury bonds, which the Federal Reserve purchased with newly printed American dollars.
This money circulated in the American economy. The money supply consists of two parts: physical notes and coins in circulation and deposits in banks. The graph below shows the total deposits in the banks – adjusted for inflation.
We see that bank deposits grew rapidly in 2020-21, but thereafter the bank deposits have fallen significantly, and we are now approaching the red line, which marks the trend before the major monetary policy easings.
It should be noted in this context that it is natural for deposits to grow in an economy that is growing underneath – but not as rapidly as in 2020-21.
It was precisely the strong monetary policy expansion that caused the bank deposits to grow so significantly in 2020-21.
But from 2021, two things happened. Firstly, inflation began to rise sharply already from 2021. With higher inflation, the purchasing power of bank deposits is eroded. This is the first factor that caused the growth in bank deposits to decline during 2021.
The second thing that happened was that the Federal Reserve began to tighten monetary policy during 2021 – and this really caused a drop in bank deposits.
But we have not yet fallen below the red line – and we can actually see signs of a “soft landing,” that is, a decrease in the rate at which bank deposits are falling. This is due to a combination of slightly increasing (nominal) bank deposits and a continuing decline in American inflation.
However, we can also see why it looks ominous. If the green line really falls below the red line (with all the uncertainty about how we measure this), then we must expect that we also hit the growth wall, and that we get an American recession. But it is not necessarily given yet.
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