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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.
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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]
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