84 4 Why Is the Economy Not Taking-Off?interest rate emerged as more important tool of monetary impact, and Keynes’analysisvia interest rate again became preeminent. Further, in times of recession, theKeynesian perception is more relevant and dominates in understanding of theinﬂuence of monetary measures. Apart from this macro angle of money supply andeconomy, it is essential to also examine microstructure of money supply. Moneysupply is deﬁned in many ways and gauged by different measures. To understandthe impact of money supply on macroeconomic parameters, one must ﬁrst ascertainthe impact of monetary expansion on different components or constituents of money.Money can be most narrowly deﬁned as currency in circulation and as widelydeﬁned to include not only demand, savings, and time deposits of banks but alsodeposits of nonbanking ﬁnancial institutions, money market funds. Another impor-tant component of money is credit. Expansion in money supply without creditgrowth is like pumping the air into leaking balloon.Where is the money going? The money is still sitting tight in the Fed in the formof excess reserves of banks with the Fed. The bank lending has not increased asdesired. The monetary base is getting bloated, but money supply is not growing fast.What has grown is the demand deposits of banks and excess reserves of banks withthe Fed. Table 4.1 shows the growth in different components of money since 1990over the last more than two decades.If we see currency M1 and M2 since the crisis, we ﬁnd that growth has been morein M1 than in M2. Compared to the growth of M1 of 2.5% in 2000–2008, thegrowth since the crisis in 2008–2012 has been record as 16.7%. The growth is indemand deposits of banks and excess reserves of banks with the Fed which havegone up from mere $1.6 billion in 2008 to a record ﬁgure $1,477 billion in 2012(Fig. 4.1). Out of the QEs of $1.9 trillion, $1.48 billion is with the Fed as reservesof banks. Money is yet to move into the productive channels of the economy. Thecredit growth has not gained momentum. Bank credit before the crisis in 2008 hadreached the high of $9.5 trillion. This level was crossed in February 2012 indicatingthe slow growth in credit demand as well as delivery. The commercial paper (CP)issues are worst affected because of the fear of holding securities. The CPs outstandingTable 4.1 Dynamics of moneyC M1 M2 M2−M1 Ex Rs Vm2 Vm1% % % %(In $ billion)1990 223 798 3,163 2,365 1 1.8 7.12000 524 (13.5) 1,140 (4.2) 4,633 (4.6) 3,493 (4.8) 2 2 8.92008 757 (5.5) 1,370 (2.5) 7,451 (7.6) 6,081 (9.2) 1.6 1.8 102012 1,060 (8.9) 2,400 (16.7) 10,123 (8) 7,723 (6) 1,477 1.6 6.9Data Source: FRED, Economic Research, Federal Reserve Bank of St. LouisC=currency in circulation, M1=C+demand deposits, M2=M1+savings and small time depositsM2−M1=savings and small time depositsEx Rs=excess reserves of banks with the Federal ReserveVm1=nominal GDP/M1, Vm2=nominal GDP/M2
85Monetary Mechanicscame down after the crisis from $2.2 trillion in 2007 to a low of $916 billion in2012. It has yet to reach its precrisis level. M2–M1, which show the savings andsmall time deposits of banks, have grown at 6% in 2008–2012 compared to 9.2% in2000–2008. The growth in money supply is totally concentrated in the excessreserves of banks with the Fed. Unless it percolates down to credit growth and intomore commercial paper, the recovery will be sluggish.The velocity of money is still at record lows. The velocity of money, M2, is theratio of GDP to M2. It shows how many times money, $ in form of M2, moves in ayear to create GDP. During the 1990s, the Vm2 went up from 1.8 to a high of 2.1before the dot-com crisis (Fig. 4.2). It dropped sharply after the crisis and to thelevel below 1.6, the lowest since 1965. Vm1 has shown more dramatic drop from 10in 2008 to 6.9 in 2012. The velocity money is yet to move up even after more than3 years of antirecession ﬁscal and monetary nutrition.Never in the history has the Fed given the lending support to the banking industryto the extent it has done after the crisis. The banking industry has never approachedthe Fed for major ﬁnancial support. Until 2008, all the banking crises which the econ-omy faced were managed by the government deposit insurance corporation, throughmergers and acquisitions in the industry and government support to the extent of $153billion. There was hardly any Fed support in the crisis. In postdepression history, theFed has been managing money supply and its cost, but was never a large ﬁnancier tothe banking industry $1.5 trillion in 2009 and to $2.5 trillion in September 2012 con-stituting 25% of money supply, M2. Huge monetary expansion has yet to translateinto credit and accelerate the production cycle and promote growth.Fig. 4.1 Excess reserves of depository institutions (Excresns). Shaded areas indicate US reces-sions. 2012 research.stiouisfed.org (Source: Board of Governors of the Federal Reserve System)
86 4 Why Is the Economy Not Taking-Off?Sluggish InvestmentOne of the main reasons why the economy still to gain vigorous growth momentumand employment is not growing at the rate it should have is that investment has notpicked up except in few consumer-oriented sectors not on the considerations ofproﬁtability but because sheer uncertainty of the overhang of Euro crisis which stillneeds to be resolved (Fig. 4.3). Until the Euro crisis comes to its logical andﬁnancially viable solution, the investment climate in the USA is likely to be some-what lackluster. While the ECB, Germany, and IMF have to be large contributors inthe ﬁnancial involvement, China, Japan, and OPEC also need to give assistance toavoid the backlash of Eurozone recession on their economies. The USA has its ownﬁscal cliff to manage and can hardly afford to extend any ﬁnance. It can extend sup-port in kind by exporting goods, including agricultural products, and swapping themagainst the Eurozone’s holdings of US government securities.The corporate America has been resilient and shown healthy growth. The sec-toral and corporate changes are a part of the economic changes and capitalisticsystem. That is what capitalistic system does to corporate on its knees. The indus-trial or sectoral changes follow the technological progress and pull of consumerdemand. The market rules and capitalism are ruthless. Market-driven capitalismdoes not spare the lax, nonresponsive, incompetent, and inefﬁcient corporate forlong. The economic Darwinism is the driving force of optimal capitalism. Thedeclining and dying sectors suffer and wither. The rising and growing sectors per-form and attract capital. In this constantly changing industrial and service sectorspace, the proactive, perceptive, dynamic, and ﬁnancially efﬁcient corporates overtakethe ones which are not.Yet, the overall results of the corporate sector give the senseFig. 4.2 Velocity of M2 money stock (M2V). Shaded areas indicate US recessions. 2012 research.stiouisfed.org (Source: Federal Reserve Bank of St. Louis)
87Infrastructure: The Growth Driverof where the economy is moving. In this context, the corporate performance hasshown progress. The post-tax proﬁts of corporate (Fig. 4.4) are growing. Under theimpact of the decline in GDP in 2009, the corporate proﬁts had shown a sharp dip.The revival of the economy in 2010 has added buoyancy to the corporate perfor-mance. Record-low interest rates and record rise in government expenditure haverejuvenated the corporate America. The stock market has gone up with Dow show-ing the rise from 10,000 to 13,000, 30% rise. Yet, the corporate America has notbeen unrolling its capital expenditure program. This is reﬂected in the record cashpile up by companies and record liquidity status of banks. The nonﬁnancial corpora-tions held cash of $1.24 trillion at the end of 2011. Apple, Microsoft, Cisco, Google,and Pﬁzer held 22% of the total. Nearly 57% of American corporate cash was heldabroad.1Until this cash moves in the economic cycle from the current ﬁnancialcycle, the economy would not take sustainable spin for growth.Infrastructure: The Growth DriverThe housing and real estate sector has been the driver of the US economy. One ofthe major handicaps of the current recovery is that the crisis was the result of theborrower’s payment defaults in the housing sector that not only led to the collapse1Moody’s Investor Service, March 14, 2012.Fig. 4.3 Gross private domestic investment (GPDI). Shaded areas indicate US recessions. 2012research.stlouisfed.org (Source: U.S. Department of Commerce: Bureau of Economic Analysis)
88 4 Why Is the Economy Not Taking-Off?in housing prices, but the avalanche of foreclosures created a huge overhang ofstock of housing units. This overhang of houses has hampered the new constructionactivity which can attract fresh investment and generate employment. The backlogof housing stock is so large that there is less scope for new house constructionexcept in areas and towns where the earlier boom had not reached or could notreach. Until this unsold housing stock is reduced sharply, new housing constructionwould not begin in a big way to give boost to employment and growth in the econ-omy. The housing sales plummeted from the peak of housing boom at 1.28 millionunits to an all time low 323,000 in 2010. The new home sales have to pick up to600,000 units to generate investment and employment in this sector.Since the housing and real estate sector will continue a laggard and fail to be thedriver of growth for a few more years to come, the other sectors have to take the leadto be the engine of growth. While the service and technology sectors comprisingseveral industries offer the right potential in the light of the demand pulls as well assupply and endowment factors, the sector which is in urgent need of refurbishmentand offers large employment potential is the infrastructure. Instead of leaving itentirely to the forces of markets, there is a need in the current environment to engagein public–private partnership in this sector. This unorthodox venture could act as thesustainable accelerator of growth in the current uncertain environment.One of the major reasons for slow growth in employment is that over the years,the employment intensity of government expenditure has gone down due to the techno-logical change as well as the shift in the composition of government expenditure.In early stage of capitalist development, government expenditure on infrastructureFig. 4.4 Corporate proﬁt after tax (CP). Shaded areas indicate US recessions. 2012 research.stlouisfed.org (Source: U.S. Department of Commerce: Bureau of Economic Analysis)
89Infrastructure: The Growth Driverwas relatively large contributing to fast growth in employment. Although theinfrastructure is not in short supply as it was in the early days of industrialization,a large stock of infrastructure is in need of refurbishment and modernization. Nowis the opportune time to allocate resources in this sector which will yield quickresults in employment generation.