But other economists think that we can know the tipping point number. In a study paper presented to the U.S. Monetary Forum earlier this yearin New York, a group of leading economists had this to say: “Countries with high debt loads are vulnerable to an adverse feedback loop in which doubts by lenders lead to higher sovereign interest rates which in turn make the debt problems more severe. We analyze the recent experience of advanced economies using both econometric methods and case studies and conclude that countries with debt above 80 percent of GDP and persistent current-account deficits are vulnerable to a rapid fiscal deterioration as a result of these tipping-point dynamics. Such feedback is left out of current long-term U.S. budget projections and could make it much more difficult for the U.S. to maintain a sustainable budget course. A potential fiscal crunch also puts fundamental limits on what monetary policy is able to achieve” (Crunch Time: Fiscal Crises and the Role of Monetary Policy, February 22, 2013).
One of the U.S. Federal Reserve’s primary roles is to control the nation’s monetary supply, called “M2,” which is the total of cash and demand deposits (such as checking and savings accounts) in the economy. Indeed, the Fed has been purchasing massive amounts of securities in the last few years in what is called “Quantitative Easing.” This drives interest rates down and also means that the securities purchases by the Fed inject huge amounts of money into the U.S. economy—in an attempt to stimulate it. The economists quoted above are saying that at the tipping point, monetary policy becomes ineffective in controlling the money supply and the economy. Is there any evidence that is the case?
Over the last five years of attempted monetary expansion, a disconnect has been brewing. In the first quarter of 2013, the Fed purchased $277.5 billion in securities, injecting that amount into the economy, but the money supply, M2, actually contracted by $55 billion during that period. This is largely because the more money the Fed injects, the slower the circulation of money—called the velocity of money (“V”)—becomes. The velocity of money is at its lowest level in over half a century. Since the economy is not using it and price levels are not increasing much, all that extra money piles up in banks, which deposit it as excess reserves in… The Federal Reserve! Over the last 5 years, the Fed’s balance sheet has ballooned from about $890 billion in early 2008 to $3.75 trillion as of mid-October 2013! It appears that not only are our regulators missing their monetary targets, they may be shooting blanks!