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Why Money Supply Matters for Draghi’s Euro Economy Amid Slowing

June 17 (Bloomberg) -- Central bankers once kept money-supply measures atop the list of indicators they monitored when managing the economy.

Inspired by Milton Friedman’s view that inflation is “always and everywhere a monetary phenomenon,” the view held through the 1970s that, as went the supply of money, so went economic growth.

As the relationship began to break down in the 1980s with advances in financial innovation, policy makers started worrying less about the monetary aggregates such as M1 or M3. The Federal Reserve announced in 2000 it would no longer set targets for money supply and six years later said it would cease publishing M3 data.

Less willing to consign measures of money to history is Holger Schmieding, chief economist at Berenberg Bank in London. For him, the M1 gauge still carries power, and for more than a decade it has served as his favorite indicator of the euro-area economy’s long-term health.

“In the region’s largely bank-based system of financial intermediation, major shifts in real M1 growth have reliably signaled key economic turning points, some three quarters in advance,” Schmieding said.

Ready Cash

Why so good? M1 adds up cash and overnight bank deposits, the money companies and households can most easily access and could spend any time they want. The measure began turning up in mid-2012, growing as much as 6 percent at the turn of the year to herald the return of the euro zone to growth in early 2013.

Since then, M1 growth has slowed toward 4 percent, the only indicator in Schmieding’s eyes to signal a downside risk to his forecast that the region will be growing at a trend pace of 1.8 percent by the end of this year. European Central Bank President Mario Draghi is among those betting on a rebound.

While finding it hard to “dismiss the warning,” Schmieding sees one strand of hope that this time is different. After the collapse of Lehman Brothers Holdings Inc. in 2008, households and companies build up unusual liquidity balances out of fear. The unwinding of those as the economy improves has meant a slowing of M1 growth yet suggests more confidence in the recovery.

“This is good, not bad, for the growth outlook,” Schmieding said. “It need not herald less growth.”

To contact the reporter on this story: Simon Kennedy in Paris at skennedy4@bloomberg.net

To contact the editors responsible for this story: James Hertling at jhertling@bloomberg.net Fergal O’Brien, Eddie Buckle

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