I have been very critical of any measure of the quantity of money that includes assets that do not serve as media of exchange. In particular, I have never thought that time deposits should count as part of the quantity of money. The arbitrary dividing line of $100,000 (between small and large time deposits) has always made M2 an absurd measure of the quantity of money. Unfortunately, the development of sweep accounts has made reported values of M1 nearly worthless. Probably the least bad option is to include all savings accounts in a measure of the quantity of money. MZM includes currency, checkable deposits, savings accounts, and money market mutual funds. The dollar value of each item is summed up.
Unfortunately, it doesn't include other overnight financial assets, especially repurchase agreements, but also other commercial paper. The Fed used to include overnight repurchase agreements as part of M3, but they were bundled with term repurchase agreements. Worse, the Fed stopped reporting M3. (As far as I can tell, there are no good measures of the volume of overnight commercial paper, though the Fed does report yields on various maturities of commercial paper.)
With modern communication and payments technology, any overnight financial asset can serve as media of exchange. When they are tied to a checkable deposit with a sweep agreement, these are funds in checkable deposits, just as are the funds reported as being in savings accounts. (In my view, sweep accounts amount to a fraudulent effort to evade reserve requirements. On the other hand, I think reserve requirements are an unjust tax, with the burden suffered by small depositors.)
I have also long rejected the inclusion of Treasury bills in any measure of the quantity of money. The Fed had a measure of the money supply it called "L," that included T-bills. The problem with T-bills is that they have a market price that adjusts based on supply and demand. While the core characteristic of money is that it serves as media of exchange, that its price is fixed in terms of the unit of account is also very important.
But as the yields on T-bills approach zero, I must admit that those who argue that T-bills approach a perfect substitute for base money become more persuasive. As I have argued many times, the zero-nominal bound on other financial assets is intimately related to monetary disequilibrium. Further, there is good reason to doubt the effectiveness of open market operations using financial assets with very low yields. But does that mean that those T-bills still held by households and firms are effectively money?
The Divisia approach provides a solution to all of these problems. While I don't think it is a perfect solution, perfection is usually not a real option. But the real reason why I find it very interesting is the charts below. It is really a surprise that nominal GDP is so far below the trend of the great Moderation?
The make up of the different measures is here. The difference between M4 and M4nt is T-bills. The divisia measures show that T-bills are providing substantial monetary services. (They are now a better, if not perfect, substitute for money.) The difference between M4nt and M3 is commercial paper. Commercial paper isn't providing much in the way of monetary services now.
I support a target rule for nominal GDP. I am skeptical regarding instrument rules--formulas that tie a policy interest rate like the fed funds rate or base money to a goal of monetary policy. However, it is certainly looking like getting the divisia M4 measure of the money supply back up to trend would be a sensible intermediate goal for the Fed. (For that matter, returning them to their previous peak might be helpful.)
That is a fascinating chart.
ReplyDeleteAs a layman, I have also always had reservations about measures of money supply, and have always been puzzled by the $800 billion in currency probably outside the USA somewhere, or the easy way one can transfer money from any number of Chinese or other foreign banks across borders (East West Bank in Los Angeles, for example), or why food stamps are not counted as money etc etc etc.
Now Woolsey in this post lists another whole range of questions as to what is money supply.
My takeaway is once again we need not fixate on nominal price indices or dubious measures of money supply. We are genuflecting in the wrong direction.
I hate to say "play to by ear" but I think it is necessary. The Fed needs to target NGDP growth by a public rules-based system, but will necessarily have to "play it by ear' on a quarter-to-quarter basis, since tracking real growth in real time is difficult.
I suppose there is hope that in a web-based information system, we can track retail sales and certain kinds of output rather well, in real time. Evidently Greenspan watched many real output indices constantly, and we should be able to do that better than ever.
All very interesting. The relevant theory is in the appendixes to my new book, Getting It Wrong. The source of the new Divisia data is the program I now direct at the Center for Financial Stability in NY City. The program is called Advances in Monetary and Financial Measurement (AMFM).
ReplyDeleteAMFM will include a Reports section discussing monetary conditions. Although not yet online, that section will address many of the concerns rightfully appearing in the excellent blogs, The Money Illusion, The Market Monetarist, and Monetary Freedom. The distinction between the AMFM Reports section and the AMFM Library, which is already online, is that the AMFM Library only relates to articles published in peer-reviewed journals and books, while the AMFM Reports section will relate to the public media and online blogs.
There will be a press release when the full AMFM site is ready to go online.
"I have been very critical of any measure of the quantity of money that includes assets that do not serve as media of exchange"
ReplyDeleteAbsolutely correct. Just check the bank debit and demand deposit turnover series.
And sweeps distort both the volume and rate of turnover statistics.
From the standpoint of monetary authorities, charged with the responsibility of regulating the money supply, none of the current definitions of money make sense. The definitions include numerous items over which the Fed has little or no control (e.g., M2), including many the Fed need not and should not control (currency). The definitions also assume there are numerous degrees of “moneyness”, thus confusing liquidity with money The definitions also ignore the fact that some liquid assets (time deposits) have a direct one-to-one, relationship to the volume of demand deposits (DDs), while others affect only the velocity of DDs. The former requires direct regulation; the latter simply is important data for the Fed to use in regulating the money supply.
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