Monetary fix

I have been argu ing here for some time that the Great Reces sion of 2007-2009 was noth ing more than a pro nounced money demand shock that the Fed er al Reserve failed to fully off set. As a con se quence, nom i nal spend ing col lapsed and given sticky prices the real econ o my crashed too. This seems self evi dent to me and other so called quasi-monetarists (a term coined by Paul Krug man) like Scott Sum n er, Bill Woolsey, Nick Rowe and Josh Hen drick son. Some folks, how ev er, do not buy it. They dis agree that the fun da men tal prob lem was a money demand shock and by impli ca tion they dis agree that the Fed could have done any thing to off set it. This think ing can be vivid ly seen in the respons es to my Nation al Review arti cle where I make the case for QE2 with a money demand shock story. A more thought ful response to my argu ment comes from Brad DeLong who says rather than a nar row money demand shock being the under ly ing cause of the Great Reces sion, it was a broad er liq uid i ty demand shock. Thus, the demand for all high ly liq uid assets increased and derailed nom i nal spend ing. Though some of the quasi-monetarists may dis agree with him on the details, I think they would agree with DeLong in gen er al and might even call him a clos et quasi-monetarist. So what is the evi dence for DeLong's the o ry of a great liq uid i ty demand shock? I went to the flow of funds data and looked up the share of high ly liq uid assets as a per cent of total assets for the (1) house hold and non prof it sec tor, (2) the non farm non fi nan cial cor po rate busi ness sec tor, and (3) the non farm non cor po rate busi ness sec tor. For high ly liq uid assets I sum up for each sec tor cur ren cy and check able deposits, time sav ing deposits, money mar ket funds and trea sury secu ri ties. Pre sum ably, the share of high ly liq uid assets as a per cent of all assets for each sec tor spiked dur ing the cri sis if in fact there was a great liq uid i ty demand shock. Here is the fig ure for the house holds and non prof it sec tor: Click to enlarge Source This fig ure shows that the share of total assets for house holds and non prof its allo cat ed to high ly liq uid assets was declin ing since the 1980s. This down ward trend was dra mat i cal ly reversed begin ning around 2007 and is still ele vat ed. Next is the fig ure for the non farm non fi nan cial cor po rate busi ness sec tor: Click to enlarge