Why the Economy Is Weak Now, But Will Be Stronger Near Yearend

Today's employment report emphasized the weakness of recent economic data.

Employment Gain

Note that the last two monthly data points are inside the red circle. In other words, employment barely grew at all. Yet we had significant growth earlier. Why did growth slow?

I'm an old-time monetarist. I won't deny some influence of fiscal policy, but we seem to be in a time when Ricardian Equivalence is undermining any stimulative impact of government spending. So I'm back to monetarism. With the Fed's second round of Quantitative Easing (QE2) wrapping up, pundits are scoffing at monetarists. However, their scoffs are premature.

Milton Friedman, the modern resurrector of monetarism, held that the time lags in monetary policy are "long and variable." If we believe the time lags are long, then it's too soon to evaluate QE2. However, it's not too soon to evaluate monetary policy from early 2010. It was pretty tepid, as we see in the chart of money supply growth.

Money Growth

In fact, over a year ago I challenged the Fed to push money supply growth up faster. I asserted that they were engaging in quantitative tightening without realizing it.

If you take one year as a rough rule of thumb for the time lag of monetary policy (ignoring the "variable" part of Friedman's conclusion), then there's no surprise that economic growth is weak right now.

What's the economic outlook for the rest of 2011? The Fed started QE2 last November, so we should begin to see early effects in a few months, with the peak impact around the fourth quarter of this year.