Going their own way
19 June 2018
Money supply matters, especially in the long run. Inflation is, after all, a monetary phenomenon - and financial history is littered with rapid expansions in the money supply preceding dramatically high inflation. But a consensus has emerged among economists that monetary aggregates have limited information content about inflation or activity over typical policy horizons, and central banks have accordingly dropped money supply growth targets. The velocity of money can change, while monetary aggregates are also affected by central bank balance sheets and changes to structures of the financial system. Overall, it' important to look at money supply numbers (often measured as M0, M1, and on up as the assets included as 'money' increase) alongside credit growth, bank lending surveys, and other leading indicators of growth and inflation.
The major central banks will therefore be fairly sanguine about the recent weakening in growth of both narrow and broad monetary aggregates (see Chart 1). In the US, weaker money growth is partly the result of Fed balance sheet run-off, while loan growth looks decent. The Fed last week hiked rates for a second time this year, and expects to do so twice more in 2018 and three times in 2019. We expect the pace of hikes to be faster still. In the UK, weaker money supply growth reflects financial institutions reversing the de-risking of money holdings undertaken after the EU referendum, and is therefore a benign development. The Bank of England is likely to hold rates steady this week, but hike in August. Slowing money growth in the Eurozone is consistent with moderating but still above-trend growth and a gradual re-emergence of inflation pressures. That assessment is shared by the ECB, which last week announced a taper of its asset purchases, albeit with the dovish rider that it expects to keep rates on hold "at least through the summer of 2019". In Japan, money creation by the BOJ has been thwarted by a meaningful deceleration in the velocity of money. Monetary policy may actually be insufficiently stimulative, but options to ease further are constrained by rising policy costs. Finally, regulatory tightening and rapid changes in the structure of China' financial system have distorted M2 as a measure of the policy stance. Policymakers have begun to loosen policy and may be moving towards an easing bias.