M2 surged in July and August, as investors and asset managers sought the relative safety and liquidity of bank deposits and other assets that make up the M2 aggregate. Notably, institutional investors, concerned about exposures of money funds to European financial institutions, shifted from prime money funds to bank deposits, and money fund managers accumulated sizable bank deposits in anticipation of potentially large redemptions by investors. In addition, retail investors evidently placed redemptions from equity and bond mutual funds into bank deposits and retail money market funds.
The growth of saving deposits is even more stark if viewed as percent of personal income:
So what can be done? My own view is that the money demand problem could be fixed by properly shaping expectations about future spending and inflation via something like a nominal GDP level target. Unfortunately, the latest FOMC minutes indicate that is not an option. So for now we lumber on, hoping that in absence of forceful and systematic Fed actions the market will be able to heal itself in a timely fashion.
Update: This figure from a previous post shows that share of liquid assets has been systematically related money velocity over the past 60 years or so.
This post originally appeared on Macro and Other Market Musings and is reproduced here with permission.
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