The Atlanta Fed's macroblog provides commentary and analysis on economic topics including monetary policy, macroeconomic developments, inflation, labor economics, and financial issues.

Authors for macroblog are Dave Altig, John Robertson, and other Atlanta Fed economists and researchers.

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January 21, 2006

Why There's No Money In Monetary Policy

Here's a pretty good explanation, from Mark Hulbert at MarketWatch:

Money may indeed make the world go 'round, as many on Wall Street are fond of saying.

But even among advisers who think that it does, there is little agreement on whether the supply of money is growing or contracting, much less what such trends might mean for the stock market.

This was brought home to me over the past week as I read different investment newsletter editors' reactions to the money supply data that the Federal Reserve periodically releases.

One veteran newsletter editor, for example, wrote this past week that "the Fed is creating liquidity at a pace that I don't think I've ever seen before."

Yet another prominent newsletter editor, reviewing the same data, concluded that the Fed's growth of the money supply has been "stingy" over the past year.

How can there be such a wide disagreement?

Part of the reason is that there are so many different definitions of money. And for each of the major definitions, furthermore, the Fed reports the data on both an unadjusted as well as a seasonally adjusted basis.

Add to that the volatility of the data, and you have a situation in which you can find data to support almost any preordained conclusion...

The man, apparently, had done some research:

As I have reported in this column before, in fact, I have been unable to find any statistically meaningful correlation between the growth rate of the money supply and the stock market's subsequent performance - regardless of whether the money supply is defined as M1, M2 or M3, on either an unadjusted or a seasonally adjusted basis. (Read archived column from last September.)...

[Madeline Schnapp, Director of Macroeconomic Research at TrimTabs Investment Research] told me that she and her fellow researchers at TrimTabs have explored the econometric relationships between the money supply data and the stock market "every which way from Sunday" -- and that they have found no straightforward correlation between it and the stock market.

As a result, she believes that changes in M1, M2 and M3 are "next to useless" as market timing indicators.

As someone involved in thinking about monetary policy, I am less interested in all the market timing stuff than I am in the trajectory of things like, oh, inflation.  But here, repeated from a post from several months back, is the opinion of the soon-to-be-departed-from-the-Fed-but-never-forgotten Chairman Greenspan:

... at least for the time being, M2 has been downgraded as a reliable indicator of financial conditions in the economy, and no single variable has yet been identified to take its place.

That was 1993.  (You can find it in print versions of the Chairman's testimony associated with the July Monetary Policy Report to Congress.)  Fast forward to 2000, and this footnote in the July Monetary Policy Report of that year:

At its June meeting, the FOMC did not establish ranges for growth of money and debt in 2000 and 2001. The legal requirement to establish and to announce such ranges had expired, and owing to uncertainties about the behavior of the velocities of debt and money, these ranges for many years have not provided useful benchmarks for the conduct of monetary policy.

The Committee did qualify things with this...

Nevertheless, the FOMC believes that the behavior of money and credit will continue to have value for gauging economic and financial conditions, and this report discusses recent developments in money and credit in some detail.

... but the days of money measures playing a central operational role in the conduct of monetary policy are, for now, gone.   It's a pity.  It's a fact.

January 21, 2006 in Federal Reserve and Monetary Policy | Permalink


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» Unstable Velocity from EclectEcon
For the first many decades of my career as an economist, it was apparent that there was a stable relationship between nominal GDP and the amount of money in the economy (especially if money was measured as M2, to include savings accounts, or time depos... [Read More]

Tracked on Feb 2, 2006 12:21:07 AM


Over time there have been structural changes in the economy so what the various measures of money supply are actually measuring changes over time.

For example M1 measures individuals most liquid assets.
But in the early 1990s two developments emerged that changed that. One was the emergence of wide spread use of money market funds. Money market funds are not included in M1, but after people could start writing checks on them the big difference in the liquidity of checking accounts and money market funds vanished.
So M1 no longer measured what it use to. Something similar happened to the difference between M2 and M1 when banks developed ways to start paying interest on checking accounts so that much of the difference between savings and checking accounts also vanished. consequently, M1 and M2 no longer measured what they use to.
So rather then using M1 and M2 you need to shift to a different measure like zero maturity money where what it measures has been constant over time.

We are seeing that now in M 3 where the behavior of foreign deposits has changed so it no longer measures the same thing it use to.

Posted by: spencer | January 21, 2006 at 12:00 PM

so why are we still teaching college kids about M1,2,3, etc. if they are useless?

Posted by: nobody | January 21, 2006 at 11:25 PM

nobody -- It's a reasonable question. A fair amount of modern macro in fact takes the perspective of "cashless economies", in which central banks control the price level through direct manipulation of interest rates (through some mechanism that is usually unstated). For my part, I think money is still the right concept to think about. So I proceed with a discussion of money and inflation, and continue with the connection between control of the short-term interest rate and it's association with money creation. In essence, I think it is correct to suppose that central banking is still about money growth -- and matching it with the growth rate of money demand. The problem is that we are still a bit short on moving from the theory to a stable emprirical definition of money. In effect we are taking the decision that the mirror image of money -- short-term interest rates -- gives us a clearer link between instruments to objectives.

Posted by: Dave Altig | January 22, 2006 at 10:58 PM

So, we all agree CPI is lousy at measuring inflation. It's extremely subjective, it wasn't designed for this purpose & it does a very poor job at it. But, using CPI as THE measurement to explain inflation serves us well because it supports arguments our government would like us to accept. This certainly makes sense from Washington's perspective. But why are tenured academic economists, whose jobs are protected from "political correctness" assaults, going along with the obvious misrepresentation? Why haven't Academics come up with a better method to produce a more reliable result? Why can't the Economics community even come together to agree on what money is? Sure we live in a dynamic world & the opportunity use of money is continually changing, but it's not like we're stuck in the 50s. There's a whole lot of information out there at your disposal. Is there no one who sees a benefit to explaining inflation using definable terms & objectively measurable data? Is the problem simply that there's not a lot to be gained from telling the Emperor about his new suit? Whatever the reason, it doesn't explain why so many Economists are so hostile to the failings of the Bush Administration. Or, does it?

Posted by: bailey | January 23, 2006 at 04:39 PM

bailey -- There's a few different questions floating around in there, but let me address the one directly related to this post. My interpretation of why there is not a lot of energy put into the development of monetary measures with predictable velocity is (a) as you mention, transactions technologies are changing more rapidly than our capacity to tease stable relationships out of the data -- note that this is a problem of small-sample statistics as much as anything; and (b) policymakers and academics alike are quite satisfied that we can get the right answers by targeting short-term interest rates (John Taylor and Mike Woodford, in other words, have ascended to the Friedman throne). If either one of these conditions changes, I think you would see some renewed interest in the search for a stable monetary aggregate.

Posted by: Dave Altig | January 24, 2006 at 09:24 AM

I don't see how Hulbert's piece contributes to the topic. The issue is monetary policy, inflation, money - not the stock market.

Posted by: vailey | January 25, 2006 at 04:12 PM

One major problem is Goodhart's Law. Basically, economies are more complex than such simple phenomena as astrophysics. When the Central Bank targets a monetary aggregate, and people know that it is targeting an aggregate, they change their behavior to take that into account. Then the historical relationship between the aggregate and other economic variables no longer has predictive power. The stars and the planets don't behave differently as a result of our watching them.

Posted by: Acad Ronin | February 02, 2006 at 10:48 AM

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