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Friday, November 10, 2006

Money Supply As An Economic Forecaster

Are money supply figures a useful measure of future economic performance? Well Ben Bernanke certainly doesn't seem terribly convinced they are:

"Forecast errors for money growth are often significant, and the empirical relationship between money growth and variables such as inflation and nominal output growth has continued to be unstable at times," Bernanke said in prepared remarks to a European Central Bank conference in Frankfurt.

As is well known ECB President Jean-Claude Trichet isn't terribly convinced by Bernanke's argument at this point, and throwing off suggestions that he was a 'monetary luddite' Trichet told the FT yesterday that despite the fact that other central banks, including the US Federal Reserve, are sceptical about the use of such measures and despite his acknowledgement that “the dominant academic view seems to be that monetary aggregates should have no part in monetary policy decisions”, he still “cannot dispel my doubts that a model of monetary policy that includes no role for money is incomplete in some important respects.”

Of course I doubt that anyone, including Ben Bernanke, is suggesting there should be *no* role for monetary aggregates. What is at issue is the importance you give to those aggregates and the interpretation you put on them. This is the main point at issue in the Eurozone at the present time.

Which takes us back to a debate that the Morgan Stanley GEF team had in July 2005 about whether or not the Eurozone economies might have slipped into a sort of liquidity trap (here's a link to the debate itself, which was very interesting). Now it is extremely unlikely that the entire Eurozone would be in such a trap, but some parts of it - and especially the German economy - are notably resistant to large increases in available liquidity.

Who is right? This is a good question, and one Claus Vistesen has been struggling to get to grips with himself:

So who is right? Well, I have argued continously here at Alpha.Sources that I think the ECB is playing into the hands of the impending recessionary outlook for the Eurozone going into 2007 raising rates. Inflation is below target as a result of a dropping headline and the recovery itself is anything but sustainable. However, the broad based monetary indicator (M3) is still above target and corporate and private lending remains buyoant. But do I really side with the finance ministers here?

It really does not matter in this case since the real point here is that the ECB is a central bank and as such (should be) independant from policy. We have had this discussion before and despite all my rants about the inherent problems of the Euro as a project the independance of the ECB as an institution is very important ... if it was to become a quasi-political forum we might as well shut the whole thing down. Underneath this is of course the underlying paradox of the ECB's task of keeping a single interes rate to suit all Eurozone economies faced with huge strucutural imbalances which in my opinion (and get ready here) first and foremost are driven by the widely differing population structures of the Eurozone countries.

Here maybe it would be appropriate here top leave the last word to uncle Milton himself. Try this from a sort of minor scoop I had here on Bonobo some time back: Targeting the Quantity of Money........"has not been a success"

Hold on to your hats and prepare to be amazed: Milton Friedman has changed his mind. "The use of quantity of money as a target has not been a success," concedes the grand old man of conservative economics. "I'm not sure I would as of today push it as hard as I once did." Granted, this is hardly a conversion of Damascene significance. But, heck, it's a start. It also shows that, at the age of 91, Friedman still has his critical faculties intact. The man once described as "the most consequential public intellectual of the post-war era" is still engaged - and engaging.

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