I was reading the recently published January 2012 Monthly Bulletin from the ECB yesterday. It provides a massive amount of interesting data about the developments in the Eurozone plus analysis. The descriptive analysis is fine (this went up, this went down) but the conceptual analysis leaves a lot to be desired. This is an institution that still talks about reference values of broad money as a policy target to control inflation. Basically, that idea has no application in our monetary system. But that aside, the release of the latest M3 data tells us how bad things are getting in the Eurozone and do not augur well for the coming year, despite the up-beat forecasts for real GDP that the ECB are still providing. The latest ECB data shows how bad things have become in Euroland.
You will note that in Modern Monetary Theory (MMT) there is very little spoken about the money supply. In an endogenous money world there is very little meaning in the aggregate concept of the money supply. I will come back to that.
But the Central banks do still publish data on various measures of money and attach importance to movements in these data series.
Chapter 2 of the January ECB Monthly Bulletin covers "Monetary and Financial Developments". The ECB said:
The annual growth rate of M3 declined strongly to stand at 2.0% in November 2011, down from 2.6% in October … On the one hand, three-quarters of this moderation in annual M3 growth is explained by a base effect related to sizeable interbank transactions traded via central counterparties (CCPs) in November 2010. On the other hand, the month-on-month growth rate was modestly negative at -0.15% in November.
In fact, the latest data available from the ECB shows that the M3 growth rate has decelined further (annualised) to 1.6 per cent in December 2011.
What is M3 and why might it tell us something significant about the current state of the Eurozone?
The ECB say that:
Broad money (M3) comprises M2 and marketable instruments issued by the MFI sector. Certain money market instruments, in particular money market fund (MMF) shares/units and repurchase agreements are included in this aggregate. A high degree of liquidity and price certainty make these instruments close substitutes for deposits. As a result of their inclusion, M3 is less affected by substitution between various liquid asset categories than narrower definitions of money, and is therefore more stable.
M3 is often the measure of the money supply that economists focus on with respect to their outlook for inflation. I will come back to that soon.
The following graphic is taken from the ECB Home Page and provides an easy reference to the increasingly broader definitions of the money supply.
The following graph shows the annual growth in seasonally-adjusted M3 from September 1998 to December 2011 for the entire Eurozone. You can get the data from the ECB Data Warehouse if you are interested.
The ECB say that the:
Overall, as in October, the weak monetary developments continued to reflect the high levels of economic and financial market uncertainty … The slowdown observed in the annual growth of M3 in November mainly reflected sharp declines in the annual growth rates of marketable instruments and, to a lesser extent, short-term deposits other than overnight deposits.
I will return to this point later. But first some background.
Mainstream macroeconomists think that M3 is a child of the monetary base. Underpinning this notion is the concept of the money multiplier.
A central tenet of mainstream macroeconomics that follows from the concept of the money multiplier is that the central bank is to control the money supply.
Neither the money multiplier nor the concept of central bank control of the money supply is a valid representation of the way the monetary system operates even though it appears in all mainstream macroeconomics textbooks and is relentlessly rammed down the throats of unsuspecting economic students.
The money multiplier myth leads students to think that as the central bank can control the monetary base then it can control the money supply.