Most monetary economists, and British monetarists in particular, focus on trends in broad money and credit when forming an assessment of monetary conditions. The approach here considers narrow money developments, additionally, to contain important information, particularly for forecasting purposes.
The dominance of broad monetarism partly reflects the influence of Friedman and Schwarz, who emphasised a broad measure in their seminal A Monetary History of the United States, 1867-1960. In the UK, leading monetarists, including Professors David Laidler and Tim Congdon, have framed theories of monetary equilibrium in terms of broad money.
A further reason for the neglect of narrow money is a widespread tendency to confuse the concept with the monetary base, i.e. currency in circulation and bank reserves held at the central bank. QE policies, clearly, have disrupted any relationship that existed between the monetary base and the economy.
Narrow money, by contrast, refers to forms of money that can be used by non-banks to make final payment when purchasing goods, services or assets. A narrow money aggregate should, at a minimum, include currency held outside the banking system and checkable deposits; not all instant-access deposits, however, can be used in immediate, final settlement. In practice, data availability constrains the construction of an “ideal” aggregate; the nationally-defined M1 measure is used for most countries followed here. Narrow money, to repeat, does not include bank reserves so is not automatically boosted by QE.
Broad monetarists continue to dominate the airwaves, enjoying support from prominent media commentators, but their forecasting performance has been distinctly patchy in recent years. Narrow money signals, by contrast, have been generally reliable.
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Global real narrow money contracted ahead of the 2008-09 recession; broad money growth slowed but remained solid by historical standards – see chart.
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The broad monetarists forecast “double dips” in 2010 and 2011 as real broad money growth fell below the low reached in the 2008-09 recession; narrow money, by contrast, signalled that economic expansion would slow but remain respectable.
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Real narrow money growth fell sharply around end-2011, warning of economic weakness in mid-2012; broad money expansion was solid and stable over this period.
The narrow monetarists have scored additional major wins at the country level. In particular, narrow money gave a much stronger signal that the Eurozone crisis would abate from late 2012, and that UK economic growth would far exceed official and consensus expectations in 2013.
Global real narrow and broad money are currently giving a consistent message: growth has moderated since spring 2013, suggesting that economic expansion is close to a peak but will remain respectable in early 2014.
There are, however, divergences at the country level. Broad monetarists, for example, are warning of a “triple dip” in the Eurozone because real M3 has recently stagnated, but M1 continues to expand solidly, suggesting that a slowburn economic recovery will proceed. There is an opposite signal in China, with narrow money giving a more downbeat message for economic prospects.
The dominant influence of the broad monetarists combined with their evident inability to produce reliable forecasts may explain why economists generally continue to devote little attention to monetary analysis. This may allow narrow monetarists to retain a forecasting advantage but policy-makers are likely to make further mistakes while they neglect important monetary signals.