Money Again Seen Making Economies Go Around for Central Bankers

  • Standard Chartered economists say ‘Divisia’ measure works
  • Money supply growth suggests stimulus needed, report says

It was a decade ago last month that the Federal Reserve stopped publishing a once key-measure of money supply.

So-called M3 was consigned to the scrap heap, perhaps marking the end of an era when money was thought to make the world economy go round.

In the 1970s and into the 1980s, the likes of Fed Chairman Paul Volcker and U.K. Prime Minister Margaret Thatcher all targeted monetary aggregates in their bid to control inflation.

Then policy makers switched to shifting interest rates and inflation targets came into favor, remaining so today even after being blamed in some quarters for enabling the recent financial crisis.

Among the reasons money supply went out of fashion were doubts over what it signaled in terms of economic growth or inflation, a difficulty in tracking it at a time of financial innovation plus the suspicion that it was probably better to monitor credit. Now, economists at Standard Chartered Plc are suggesting it’s time to resurrect money as an indicator, focusing on one gauge named after the late French economist Francois Divisia.

Rather than just adding together different forms of money, Divisia weighs each depending on how it meets the traditional definition of money such as the ease and convenience of use or reliability as a store of value. So cash is given a higher weighting than a time deposit.

Encouraged by surveys which showed changes in the supply of Divisia money to be reliably correlated with gross domestic product, economists Enam Ahmed, Samantha Amerasinghe and Chidu Narayanan formed their own measure of what they called a “forgotten indicator” in a March study. They found growth of 4 percent tends to correlate with slow GDP expansion, while anything above 7 percent in developed economies points to overheating.

At a global level, Standard Chartered’s aggregate index for six regions, including China, accelerated last year. That’s still more slowly than before the financial turmoil in 2008, supporting the economists’ view that global growth will remain disappointing and more monetary stimulus is required.

Breaking down the data by individual economies is more revealing. China’s measure ran at the fastest pace in three years in 2015, justifying Standard Chartered’s forecast for 6.8 percent economic growth this year, which tops the 6.5 percent median forecast of economists surveyed by Bloomberg.

There was also a decent bounce in the euro area’s reading last year toward its pre-crisis pace, suggesting an upside surprise in its economy is possible. As for the U.S., slow expansion in its Divisia measure supports the Standard Chartered forecast of just 1 percent growth in 2016, below the 2.1 percent in the Bloomberg survey.

The upshot is central bankers and economists should again tune into money supply to understand where their economy is headed, according to Ahmed, Amerasinghe and Narayanan.

“Divisia money is a good measure of monetary policy stance and a useful indicator for GDP trend,” they said. It “is not a magic crystal ball but we believe analysts should add it to their dashboard.”

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