The science of measuring the money supply can be artfully constructed
I WISH people were banned from talking so loosely about the money supply. It’s like someone telling you that “the London underground station is closed”. Unless you know which one, it isn’t very helpful.
There are a number of ways to measure the money supply, but the main problem is that they often fail to capture the essence of money – which is defined as the generally accepted medium of exchange. Narrow measures, such as the old M0, ignore the fact that people can use their current accounts as a direct source of payment. Broad measures, such as M4, incorporate assets that need to be liquidated before they can be used for transactions.
When the Bank of England makes decisions about the necessity and efficacy of quantitative easing, they chiefly look at M4, the broad money supply. However, in May 2009 they decided that deposits of “other financial corporations” were undermining M4 and released a new version, M4ex, which stripped them out. This was all in good timing, because while M4 was suggesting that the money supply was expanding by 12-18 per cent throughout 2008/2009, M4ex showed that it fell from over 10 per cent growth to about 4 per cent. This is far more consistent with common sense, but with two conflicting measures there is scope for economists to “trust” whichever fits their prior beliefs.
Indeed, the recent debate over QE3 rests on an estimate of what would happen to broad money growth with and without further monetary stimulus. As the chart shows, those advocating more money pumping are wont to focus on the traditional measure of M4, which is suffering from an ongoing monetary contraction. However, M4ex is growing at a positive, moderate rate.
There is also scope for other measures, and a richer conversation about how to measure the money supply. In the US, money of zero maturity (MZM) has emerged as a complement, occupying a middle-ground between narrow and broad money. Kaleidic Economics – the London-based business roundtable that I direct – currently publishes a similar measure called the Austrian money supply (MA).
MA has revealed strong monetary growth throughout 2011. In the first few months of 2012 it has been growing at above 5 per cent per annum. This suggests that the monetary authorities might be reinflating the bubble that caused the 2008 recession.
Anthony J. Evans is associate professor of economics at ESCP Europe Business School.
www.anthonyjevans.com Twitter: @anthonyjevans