Friday, January 7, 2011

No news from the money supply front

I've been a fan of the M2 measure of money for a very long time. It's been the most stable definition of money, and it's had the best correlation to the economy of any other measure. As these charts show, the behavior of M2 over the past 15 years hasn't changed much at all. There have been periods of faster growth (2001-2003, 2008-2009), but they have been followed by slower growth, with the result that M2 has grown on average about 6% a year. That's a little faster than the 4.7% annualized growth rate of nominal GDP over the same period, but not by much. Importantly, there is nothing here to suggest that M2 is growing faster or slower than it has for a long time; no sign of any inflationary impact from QE2, and no sign of anything that might be deflationary.

Some worry about the recent pickup in M1 growth, with M1 now growing at a 19.4% annualized pace over the past 3 months. But since M1 is a component of M2, and M2 shows no sign of any significant pickup in growth, then what is happening is that money is migrating out of the M2 definition of money and into the M1 definition. It's the same amount of money altogether, but some of it is shifting from one bucket to another. So there is no real message in rapid M1 growth.

Currency in circulation, another component of M2, is behaving normally, growing at a 6-7% pace.

So the news from the money supply front is that there is no news: no sign of inflation, no sign of deflation, and no sign that the economy is being starved for liquidity. I suppose that's good news, since for the time being there is no cause for great concern here.


Public Library said...

What is your basis for claiming 6%+ money growth is "normal"? There is no scientific evidence to prove this is either normal or necessary.

All we know is 6% money growth devalues the dollars we hold...

Scott Grannis said...

6% is approximately the long-term rate of growth of nominal GDP. Money has to grow to accommodate a growing economy. 6% money growth is "normal" because that is what it has been for several decades, during which time inflation has been relatively low. I don't mean to say that 6% is optimal, simply that it is nothing out of the ordinary.

Public Library said...

All I am saying is there is no scientific evidence to prove a Central Bank needs to print money to facilitate the growth of an economy.

In fact, economies grew surprisingly (or not so surprisingly) well long before money printing arrived on the scene.