Welcome to European Tribune. It's gone a bit quiet around here these days, but it's still going.

The Fed is eliminating the canary in the mine

by Jerome a Paris Mon Apr 3rd, 2006 at 09:07:52 AM EST

Guess what indicator predicted the last recessions?

and guess which indicator the Federal Reserve has decided not to publish anymore?



On March 23, 2006, the Board of Governors of the Federal Reserve System will cease publication of the M3 monetary aggregate.


As the Economist reminds us:



As Milton Friedman famously said, "Inflation is always and everywhere a monetary phenomenon." Monetary aggregates are a fickle guide to the economy over the next year, but over longer periods the link between money and prices still holds. Many big mistakes in economic history were made when policymakers ignored monetary signals: the Great Depression in the 1930s, the great inflation of the 1970s, and the financial bubbles in Japan in the late 1980s and East Asia in the late 1990s.

Those experiences surely suggest that central banks should keep a close eye on the growth in money alongside their immediate inflation goals.

From another article:



Money still makes the world go around. For some policymakers, anyway

it would be foolish to conclude that money does not matter. Throughout history, rapid money growth has almost always been followed by rising inflation or asset-price bubbles. This is why Mr Issing, virtually alone among central bankers, has continued to fly the monetarist flag.

The ECB's monetary-policy strategy has two pillars: an economic pillar, which uses a wide range of indicators to gauge short-term inflation risks, and a monetary pillar as a check on medium- to long-run risks. The monetary pillar has attracted much criticism from outside the ECB; it is often dismissed as redundant, if not confusing. It was originally intended to guard against medium-term inflation risks. More recently, Mr Issing has justified the pillar as a defence against asset bubbles, which are always accompanied by monetary excess.

(...)

Unlike some central bankers, Mr Issing loves to be challenged, so he invited Don Kohn, a governor of the Fed, to tackle the ECB view that a central bank should sometimes "lean against the wind" to prevent an asset bubble inflating, by tightening policy by more than inflation alone would require. Mr Kohn argued the usual Fed line: because of huge uncertainties, it is too risky to respond to bubbles and therefore it is safer to "mop up" by easing policy after a bubble bursts. He tried to present the Fed's approach to asset prices as the neutral one, ie, less activist than the ECB's. But that is misleading. There is no such thing as "doing nothing". Under the Fed's approach, unfettered liquidity sustains a bubble.

This link between money and asset prices is why the ECB'S twin-pillar framework may be one of the best ways for central banks to deal with asset prices. A growing body of academic evidence, most notably from economists at the Bank for International Settlements, suggests that monetary aggregates do contain useful information. Rapid growth in the money supply can often signal the build-up of unsustainable financial imbalances, as well as incipient inflation.

To simplify:

  • the Europeans follow money growth closely, and have been accused of being needlessly restrictive in their monetary policy, and to worry too much about non-existent threats (inflation) - and thus of strangling growth;

  • the Fed has had, for most of the Greenspan years, a policy of easy money, and even easier money in times of crisis (most crises having caused, of course, by imbalances generated by the presence of too much of the easy money they provided in the first place). Their justification has been that it is impossible to determine asset bubbles, and thus it is better to deal with the aftermath - thus the policy of debt, debt, more debt to keep consumers spending

  • the Germans say explicitly that M3 is a good medium term indicator of imbalances and bubbles, and the Bundesbank then, and the European Central Bank today, uses it as an explict policy tool against bubbles;

  • today, the M3 shows clear signs of froth again in the USA (in fact, it never stopped since the mid-90s):

    (Note that the Fed rate was stuck at 1% between 2002 and 2004, an unprecedentedly low);

  • And, hey presto, let's hide the relevant information.

Yes, let's hide the most obvious sign that there is indeed a monetary bubble (i.e. something that can be blamed squarely, unambiguously at Greenspan's feet), so that people do not worry unduly, and the cheerleaders in brokerage houses and the business press can keep the happy refrain of growth and "borrow, buy, borrow, buy, borrow, buy".



from the Economist again

So, in scrapping M3, the Fed is looking like the odd man out.

Research by the Bank for International Settlements has confirmed that monetary aggregates do still contain useful information. In particular, rapid growth in money and credit as well as asset prices usually signals the build-up of economic and financial imbalances, which often cause financial stress later on. Central banks cannot use the money-supply numbers as a way to set monetary policy on auto pilot: but they would be foolish to ignore the hazard warning lights.

Unplug the hazard warning lights. Sounds par for the course for this administration.

Display:
Also crossposted on dKos for your kind consideration:

http://www.dailykos.com/story/2006/4/3/934/94792

In the long run, we're all dead. John Maynard Keynes

by Jerome a Paris (etg@eurotrib.com) on Mon Apr 3rd, 2006 at 09:08:53 AM EST
Oi.  You know they're going to be driven insane by this, don't you?  Don't get me wrong: I love the Kossacks.  But they tend to get a little weird when economics comes up.

Be nice to America. Or we'll bring democracy to your country.
by Drew J Jones (pedobear@pennstatefootball.com) on Mon Apr 3rd, 2006 at 12:37:38 PM EST
[ Parent ]
That's why it's better to discuss the econ stuff over here.  Smaller and more attentive group.
by Hoya90 (hoya90jmk-at-yahoo-dot-com) on Mon Apr 3rd, 2006 at 06:00:39 PM EST
[ Parent ]
Well, that, and EuroTribbers tend to have a much greater understanding of economics than Kossacks, in my opinion.  The Kossacks, especially in an election year, are a little overly emotional.  It's that classic American tendency to love psychodrama, I guess.

Be nice to America. Or we'll bring democracy to your country.
by Drew J Jones (pedobear@pennstatefootball.com) on Tue Apr 4th, 2006 at 12:17:32 PM EST
[ Parent ]
Mr Kohn argued the usual Fed line: because of huge uncertainties, it is too risky to respond to bubbles and therefore it is safer to "mop up" by easing policy after a bubble bursts.
Sounds just like the Bush administration's approach to climate change...

A society committed to the notion that government is always bad will have bad government. And it doesn't have to be that way. — Paul Krugman
by Migeru (migeru at eurotrib dot com) on Mon Apr 3rd, 2006 at 09:49:54 AM EST
Form the second link (to the Federal Reserve's "statistical release"):
M3 does not appear to convey any additional information about economic activity that is not already embodied in M2 and has not played a role in the monetary policy process for many years. Consequently, the Board judged that the costs of collecting the underlying data and publishing M3 outweigh the benefits.
To paraphrase: "we haven't been looking at our own data for a while, so why bother any longer?"

A society committed to the notion that government is always bad will have bad government. And it doesn't have to be that way. — Paul Krugman
by Migeru (migeru at eurotrib dot com) on Mon Apr 3rd, 2006 at 09:54:13 AM EST
This doesn't concern me too much.  My understanding is that the Fed is correct in saying that M2 is the serious indicator.  It's easily the dominant force in the Index of Leading Indicators, as I remember.  All the same, I agree with the conclusion that states we should continue publishing M3.  Economics is all about information.  The more information you know, the more rational you're capable of behaving.  Why throw away information?

I'm waiting for Bernanke to begin talking-up the inflation target.  The Supply-Siders don't think he'll try it, but I do.  This is America, and, when in doubt, it's better to put our policy-makers in straitjackets, because they tend to get sloppy after a while.  I don't think Bernanke is going to be the dove that Greenspan was, despite his militant anti-deflation arguments.  In all honesty, I share Bernanke's hatred and fear of deflation, when it's driven by the money supply, as opposed to productivity.  And I would reluctantly agree with the idea that asset bubbles are better than contraction, but I think the answer is to try to keep a steady rate of inflation and avoid both to the greatest degree possible.

Interesting correlation on the inflation-money chart.  Note that it's not quite one-to-one, and, in a couple of cases, not really even close.  Friedman is, of course, correct that inflation is always the result of too much money being pumped in, but the reason it works in the Keynesian recession framework is because the price rise will be the result of demand picking up to too-strong a level for maximization at the given price.  So businesses then raise their prices.  The consumers will spend because they've got more money and no higher prices (yet).

There is a lot to talk about based solely on that graph.

Be nice to America. Or we'll bring democracy to your country.

by Drew J Jones (pedobear@pennstatefootball.com) on Mon Apr 3rd, 2006 at 12:36:10 PM EST
actually, I think that the correlation in the money/inflation graph is driven by the high number examples. If you had a graph going only to 10% on each axis, you'd have a real muddle with no easy trend.

That makes M3 significant only on a medium term basis or for high inflation/money growth numbers, which is serious enough.

In the long run, we're all dead. John Maynard Keynes

by Jerome a Paris (etg@eurotrib.com) on Mon Apr 3rd, 2006 at 01:08:09 PM EST
[ Parent ]
Impressive. My own article on the subject was just about copying cartoons from random blogs :).
by Laurent GUERBY on Tue Apr 4th, 2006 at 03:59:01 PM EST


Display:
Go to: [ European Tribune Homepage : Top of page : Top of comments ]