Economists Debate Mystery of Money

iF the economic recovery continues at a healthy pace, the economics textbooks will have to be rewritten.

That's what Robert Parks, a New York consulting economist and economics professor says. He's concerned about the "restrictive" monetary policy in the United States pushing the economy into a renewed slump or at the least stagnation.

Contrariwise, Michael Keran, chief economist for Prudential Insurance Company of America, describes the Federal Reserve's policy "as extraordinarily easy." He's expecting about 4 percent real growth in economic output this year.

This division is not just a typical difference in forecasts among economists, but something deeper. Mr. Parks is looking at the decline since December in the broad measures of the nation's money supply - the fuel for economic activity. The textbooks say this should slow down the economy in the months ahead.

Mr. Keran puts his trust in relatively low interest rates and the rapid rise, at least until recently, in bank reserves. "The Fed is pumping in liquidity, but it is not showing up in bank credit or bank loans," he says. "You have got to take into account tight regulatory measures."

On balance, he expects continued solid economic growth.

Keran and other optimistic economists hold that the economy has changed and that the shrinkage in broad measures of money in the past four months won't pull the economy down.

In effect, that's what Federal Reserve Board chairman Alan Greenspan told Congress in February when he spoke about "the uncertainties in the economic outlook and in the relationship between the monetary aggregates and the economy."

But economist Anna Schwartz, who with Milton Friedman authored a classic history of US monetary policy, says the Fed policy is "foolhardy." The Fed, she says, should be concerned that M-2 - a measure of money that includes currency, checking accounts, money market mutual funds, and savings accounts - is not growing. After a lag, changes in M-2, she says, do affect the level of income in current dollars and inflation.

The dispute over what monetary variable to follow may, in Dr. Schwartz's language, "sound very esoteric." But many in financial circles keep a close watch. The Wall Street Journal and other publications print the latest money statistics each week.

For example, Paul Travia, chief investment officer of Daiwa Bank Trust in New York, says he is "antsy" enough about the lack of stimulation to the economy that he is "much more cautious" than he has been for a long time in managing $350 million of pension money. "I am not a net purchaser of stocks," he says.

Mr. Travia says the Fed is tight, fiscal policy has not yet become stimulative, and banks "seem to be nothing but proxies for bond funds." Banks have been buying large amounts of Treasury securities, but not increasing their volume of business loans - loans that boost economic activity.

Economists offer a standard monetary equation, MV equals PT, which means that (M) money times (V) velocity equals (P) average prices of output times (T) real output. Though economists generally accept the equation as valid, they often disagree on how to measure money. And they note that if there is a change in the velocity of money (how fast money turns over), it will alter output or inflation on the other side of the equation.

Parks points out that the current recovery has depended on a rise in velocity since M-2 grew only modestly last year and has shrunk this year. Such a decline in the money supply in the midst of a tenuous recovery has not happened in the postwar years. Parks asks whether the combination of tight money, government spending cuts, and higher taxes will choke off business, depress money velocity, and send the economy back down again.

Keran notes that bank reserves have grown 15 percent over the past year and figures that should be enough if banks start to loan again. The Shadow Federal Open Market Committee, a group of private economists named after the Fed's policymaking body, say the Fed has been too generous and thus inflationary.

The next big test of which side is right will be April 29 when the first estimates of national output in the first quarter are released. Most observers expect Fed officials to quickly lower interest rates if they see evidence of a weakening recovery.