U.S. M2 Money Supply Grew 5.4% in July, Fastest Pace Since 2022

The U.S. M2 money supply expanded by roughly 5.4% year over year in July, marking the fastest growth rate since June 2022. This acceleration occurred as the Federal Reserve navigated a period of persistent inflation, with the Consumer Price Index registering at 3.4% year over year in August on a seasonally adjusted basis.

The increase in M2 follows the Federal Reserve's decision to end quantitative tightening in December of the previous year. During that period, the central bank had allowed maturing bonds to roll off its balance sheet without reinvesting the proceeds, a process that drained liquidity from the economy. Concurrently, the Fed initiated reserve management purchases to address tightening conditions in overnight funding markets that supply bank reserves, effectively restarting bond-buying activities.

M2 includes M1, which comprises cash in circulation and easily convertible funds such as those in checking or savings accounts, plus time deposits under $100,000 and money market funds. Some economists view the money supply as a leading indicator of inflation, operating on the premise that increased circulation drives demand and subsequently raises prices. Other factors contributing to the recent rise in M2 may include the transfer of profits from rising asset and stock prices into accounts included in M2, as well as growth in bank lending.

The relationship between M2 and inflation remains a subject of considerable debate among policymakers and economists. Former Federal Reserve Chair Jerome Powell told Congress five years ago that M2 "doesn't really have important implications for the economic outlook" and that the classic relationship no longer holds. In contrast, current Fed Chair Kevin Warsh has highlighted M2 as a tool to "measure the stock of money." During a congressional hearing, Warsh suggested that had the Fed monitored M2 more closely during the pandemic, it might have anticipated the surge in inflation. Between May 2020 and March 2021, the M2 money supply grew at least 20% annually each month, reaching nearly 27% in one instance.

Warsh emphasized that he is not a monetarist and that no single data point provides a complete picture of inflation dynamics. He stated that modern central bankers should utilize a mosaic of information to assess economic conditions. Current inflation pressures are also influenced by supply-side factors, including higher oil prices. While the recent acceleration in M2 growth coincides with a period where inflation has not shown clear progress toward the Fed's 2% target, the direct causality between money supply expansion and price increases remains contested.