The “monetarist” rule is that money supply changes lead activity by about six months and inflation by about two years. The forecasting approach here emphasises narrow money – currency plus sight deposits – when applying the rule. This approach was the basis for forecasts that the Eurozone economy would recover from late 2012 and inflation would bottom around end-2013, reviving in 2014-15.
The first forecast has proved correct and current monetary trends point to the economic upswing continuing through late 2014, at least. The “flash” April purchasing managers’ output index released last week was the highest since May 2011 and consistent with quarterly GDP growth of about 0.5% (not annualised). Six-month real narrow money* expansion remains robust, according to March statistics released today – see first chart.
The jury has yet to return a verdict on the inflation forecast. The annual increase in core consumer prices – excluding energy, food, alcohol and tobacco – fell to 0.7% in December 2013 and revisited this level in March, partly reflecting a drag from Easter timing effects. The expectation here remains for a gradual recovery in price pressures through 2014.
Real money** growth was much weaker in peripheral economies than in the core grouping over 2010-12 but this gap closed in late 2013 and recent trends remain similar – second chart. The message is that economic recovery is now broadly-based across countries, increasing confidence in its sustainability.
The final chart shows real money growth in the big four economies. The range is unusually narrow, signalling similar economic prospects. The most notable recent change is a pick-up in France, suggesting that economic news will surprise positively later in 2014.
Broad money and credit trends remain weak but neither predicted the extent of the recent economic recovery. The demand to hold broad money has been depressed by falling deposit interest rates*** while bank lending is loosely correlated with the economic cycle, with a tendency to lag.
*Real non-financial M1, i.e. currency and overnight deposits of households and non-financial firms deflated by consumer prices.
**Real non-financial M1 is not available by country; the second and third charts refer to real overnight deposits and include holdings of non-bank financial firms.
***Equivalently, the velocity of circulation of broad money has risen.
