VAN R. HOISINGTON AND LACY H. HUNT: Money growth must match potential output plus the 2% target, adjusted for velocity, which puts the non-inflationary benchmark near 3% today

The Gist

Hoisington and Hunt say the economy can absorb money growth of about 3 percent a year without extra inflation: about 2 percent for real growth, 2 percent for the Fed's target, minus about 1 point because money is changing hands faster. This is a steelman: Van R. Hoisington and Lacy H. Hunt's arguments are reconstructed in their strongest fair form, not endorsed.

Conclusion

The non-inflationary rate of broad money growth today is about 3 percent a year (range 2.75 to 3.25 percent): roughly 2 percent potential real growth plus the 2 percent inflation target, less about 1 point for rising velocity.

Premises

1. Sustained inflation occurs when money expands persistently faster than real output, so the rate of money growth consistent with stable prices depends on the economy's productive capacity and the Fed's inflation target.
2. Potential real growth is labor-force growth plus productivity growth; with the labor force now growing about 0 percent and productivity about 2 percent, potential real growth is about 2 percent.
3. Adding the Fed's 2 percent inflation target gives nominal potential growth of about 4 percent.
4. Money velocity is not stable: broad money velocity fell about 0.47 percent a year from 1900 to 1952, was about flat from 1952 to 1984, rose 1.44 percent a year from 1984 to 1997, fell 2.62 percent a year from 1997 to 2021 and rose 4.16 percent a year from 2021 to mid-2026.
5. When velocity is rising, each dollar is spent faster, so less money growth is needed; velocity rose 1.1 percent over the four quarters and about 0.97 percent a year over the eight quarters to mid-2026, which justifies subtracting about 1 point.
6. Friedman's money-growth framework made no allowance for velocity because he saw it as stable during the 1950s to 1984, so the benchmark has to add that adjustment.

Assumptions

• Broad money means the Federal Reserve's broad monetary aggregate (written M-2 here), the measure the letter uses throughout.
• The relation between money, velocity, output and prices is the equation of exchange: money times velocity equals nominal spending.
• Velocity's recent rising trend continues over the policy horizon.
• Financial interest: Hoisington Investment Management manages U.S. Treasury portfolios and for decades was known for holding very long-duration Treasuries on a falling-inflation, falling-rates view. Press reports on its 2026 letters say the firm cut effective duration from about 20.9 years at the end of September 2025 to under one year by June 30, 2026, so this letter's forecast of higher long-term yields is consistent with the firm's current short-duration positioning rather than with its earlier long-duration stance. Sources: "Decades long bull turns bearish. Cites structural deficits…
• Differs: Third-quarter 2026 velocity, released October 29 after the letter, fell to 1.417 from 1.420; it is up only about 0.3 percent from a year earlier and has been nearly flat since Q3 2025, so a 1 point velocity adjustment looks too large on the latest data.
• Differs: Friedman and Schwartz documented a long secular decline in velocity and allowed for a trend in their money demand work; the k-percent rule could accommodate a predictable velocity trend but not unpredictable shifts.
• Differs: Table 1 credits the money-growth rule to Friedman's 1969 "The Optimum Quantity of Money", but that essay's Friedman rule calls for deflation at the real interest rate so that nominal rates are zero; the steady money-growth rule comes from his earlier k-percent proposal.

Analysis

Argument type: Inductive.

Potential Fallacies

• Extrapolation from a short window (P5 and the velocity adjustment in the conclusion) — The 1-point deduction projects a 4- to 8-quarter velocity rise onto the policy horizon. The argument's own velocity history shows trends reversing in sign and size across regimes, and the latest quarter is nearly flat. A trailing change is not a forecast. Even with the persistence assumption granted, the size of the adjustment is poorly pinned down.
• False precision (Conclusion (range 2.75 to 3.25 percent)) — A band of ±0.25 points is attached to a sum of rounded, uncertain inputs: labor-force growth near 0%, productivity near 2%, and a velocity adjustment that depends on window choice. Each input is uncertain by more than the band's width. A realistic range is perhaps 2 to 4.5%, so the stated band overstates the evidence.
• Identity treated as a causal or predictive law (P1 and the equation-of-exchange assumption) — The equation of exchange is true by definition. Concluding that money growth drives prices, or that a particular growth rate is non-inflationary, requires an independent causal claim and a velocity that behaves predictably. Velocity responds to interest rates, financial innovation and expectations, so it is not a fixed input that can be solved around.
• Selective windowing / post hoc segmentation (P4 and P5) — The velocity regimes have breakpoints (1952, 1984, 1997, 2021) that look chosen after the fact. The adjustment window (four or eight quarters) is one of several possible choices, giving 1.1%, 0.97% or 4.16%, with no stated rule. This makes the adjustment look more data-driven than it is.
• Mischaracterization of a source (P6 and the Table 1 attribution) — Friedman and Schwartz documented and modeled a velocity trend, and the k-percent rule could accommodate a predictable trend. The real distinction is predictable versus unpredictable velocity, not whether velocity was considered. The 1969 essay is also misattributed as the origin of the steady money-growth rule. This overstates the novelty of the adjustment but does not affect the arithmetic.

Counterarguments

These challenges are not ranked.

• Premise 5 (High impact) — The latest data show Q3 2026 velocity at 1.417 (down from 1.420), up only about 0.3% year over year and nearly flat since Q3 2025. On that basis the adjustment is a fraction of a point, and the benchmark rises to roughly 3.5 to 4%. If actual M2 growth is near that level, there is no evidence of excess money creation.
• Conclusion (High impact) — The velocity history in the argument's own premise swings from -2.62% to +4.16% a year, as large as or larger than the benchmark itself. Applying the same formula to 1997-2021 would imply a benchmark of about 6 to 7%, and to 2021-26 about 0%. A rule that gives such different answers depending on window cannot support a ±0.25 band.
• Premise 1 (High impact) — The money-to-prices link has been unreliable since the 1980s, which is why the Fed abandoned monetary targeting. Inflation is better explained by output gaps, expectations, supply shocks and fiscal conditions, and money is partly endogenous to credit demand. A money-growth benchmark may therefore have little operational meaning.
• Premise 2 (Medium impact) — Potential growth is a latent variable that depends heavily on immigration and AI-driven productivity. Plausible alternative inputs (productivity of 1 to 2.5%, labor growth of -0.3 to +0.5%) shift the benchmark by 1 point or more, swamping the stated range.
• Conclusion (Medium impact) — Velocity is endogenous to interest rates and financial innovation, so adjusting for it is partly circular. Rates that fall could reverse velocity, and the aggregate itself is distorted by deposit shifts, money-market fund flows and the 2020 redefinition of M2.
• Premise 6 (Low impact) — Friedman and Schwartz explicitly allowed for a velocity trend, so the 'new' adjustment is less novel than claimed. The k-percent rule could accommodate predictable trends and failed only on unpredictable shifts, which the benchmark does not solve either.
• Conclusion (Low impact) — The firm's recent pivot from a 20.9-year duration to under one year, and the benchmark's consistency with a higher-yield view, give a motive to read ambiguous data in a particular direction. This does not refute the arithmetic, but it raises the bar for out-of-sample evidence.

Suggested Improvements

• Uncertainty quantification — Replace the ±0.25 band with a range derived from the combined uncertainty in potential growth, the velocity trend and measurement error, or present the benchmark as scenarios under velocity paths from -1 to +1. A realistic range of roughly 2 to 4.5% would reflect the evidence and avoid overstating precision.
• Velocity adjustment rule — Pre-specify the velocity window or a smoothed trend, justify it, and show sensitivity to alternative windows (4, 8, 12 and 20 quarters). Update the adjustment mechanically with each data release, including the latest. This removes discretion over window choice and shows how the benchmark moves with new data, such as the flat Q3 2026 reading.
• Empirical validation — Backtest the benchmark across historical episodes, comparing predicted with actual inflation over 2 to 4 year horizons, and compare it with alternatives such as Taylor-type rules or nominal GDP targeting. An out-of-sample record is needed to show the benchmark has actual predictive content rather than being an accounting restatement.
• Velocity mechanism — Explain why velocity is rising (interest rates, deposit shifts, financial innovation) and what would end the trend. Without a mechanism, persistence of the trend is an unargued assumption.
• Terminology and attribution — Call the benchmark 'consistent with 2% inflation' rather than 'non-inflationary'. Correct the Friedman attribution by crediting the k-percent proposal and acknowledging Friedman and Schwartz's velocity-trend work. This avoids misleading general readers and removes an easily exploited source error that distracts from the core analysis.
• Alternative drivers and disclosure — Acknowledge fiscal, supply and expectations channels of inflation and the endogeneity of money, and state the firm's positioning interest within the analysis itself. This makes the framework's limits clear and lets readers weigh the interest context directly.

Scenario Tests

• Velocity stays flat, as the Q3 2026 reading suggests, so the adjustment falls to about 0.3 points. (Challenges) — The benchmark rises to about 3.7 to 4%. Following a 3% benchmark would then be too restrictive, risking undershoot of nominal growth, and any claim of excess money growth at current rates would weaken.
• Velocity continues to rise at 1% a year over the policy horizon (the persistence assumption holds). (Supports) — The arithmetic yields about 3%. The result is conditional on the trend continuing, which the argument assumes rather than demonstrates.
• Velocity reverses and falls, as in 1997-2021 (about -2.6% a year). (Challenges) — The benchmark would be about 6 to 7%. A 3% rule would produce a serious monetary squeeze, showing how sensitive the figure is to regime changes the author's own data document.
• Velocity keeps rising at the 2021-26 pace of about 4% a year. (Challenges) — The benchmark approaches 0%, so the formula would label almost any positive money growth inflationary. The 1-point choice is arbitrary relative to the argument's own data.
• Immigration restrictions push labor-force growth negative while AI lifts productivity, leaving potential growth near 2% but with different composition, or a boom raises it to 3%. (Challenges) — A 1-point shift in potential growth moves the benchmark by 1 point, as much as the velocity adjustment, so the narrow band is not robust to plausible supply-side changes.
• Actual M2 growth runs well above 3% for several years while inflation stays near 2%, as in much of the 2010s. (Challenges) — Velocity or other factors absorb the excess, showing that the money-inflation link is conditional and that a benchmark based on money alone is an unreliable inflation guide.

Coherence & Relevance

The argument is coherent as a conditional calculation: if the equation of exchange holds, potential growth is about 2%, the target is 2%, and velocity keeps rising about 1% a year, the benchmark is about 3%. The premises on potential growth and the target combine cleanly. Coherence weakens at the velocity step, where the argument's own evidence of regime instability and the latest flat data undercut the extrapolation and the narrow range. The Friedman premise is peripheral and partly inaccurate. The argument establishes the method better than it establishes the number.

• Sustained inflation occurs when money expands persistently faster than real output, so the rate of money growth consistent with stable prices depends on the economy's productive capacity and the Fed's inflation target. (Strong) — Provides the conceptual framework, but as a causal claim it is contested and assumes velocity is roughly neutral. It does not itself yield the numerical benchmark.
• Potential real growth is labor-force growth plus productivity growth; with the labor force now growing about 0 percent and productivity about 2 percent, potential real growth is about 2 percent. (Strong) — Directly supplies the real-growth component. No sources or uncertainty ranges are given for the inputs.
• Adding the Fed's 2 percent inflation target gives nominal potential growth of about 4 percent. (Strong) — A direct arithmetic step. It embeds a 2% inflation rate, so the benchmark is target-consistent rather than non-inflationary in the everyday sense.
• Money velocity is not stable: broad money velocity fell about 0.47 percent a year from 1900 to 1952, was about flat from 1952 to 1984, rose 1.44 percent a year from 1984 to 1997, fell 2.62 percent a year from 1997 to 2021 and rose 4.16 percent a year from 2021 to mid-2026. (Moderate) — Motivates the need for a velocity adjustment, but also shows that any single adjustment is unreliable. It does not indicate how long the current regime will last or why the 1-point figure was chosen over 4.16%.
• When velocity is rising, each dollar is spent faster, so less money growth is needed; velocity rose 1.1 percent over the four quarters and about 0.97 percent a year over the eight quarters to mid-2026, which justifies subtracting about 1 point. (Strong) — This is the step that produces the 3% figure, but it relies on persistence of a trailing trend (stated assumption) and is weakened by later flat data. The choice of window is not explained.
• Friedman's money-growth framework made no allowance for velocity because he saw it as stable during the 1950s to 1984, so the benchmark has to add that adjustment. (Weak) — Historical framing that is not needed for the arithmetic. It is overstated, since Friedman and Schwartz modeled a velocity trend, and the Table 1 citation is misattributed.

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