Thursday, November 09, 2006

Why Money Is Relevant

Reportedly, there is pressure on the ECB to do away with its formal targeting of money supply growth, just like virtually every other central bank have. Well, given the fact that the ECB have in practice consistently ignored money supply and kept interest rates low despite the fact that money supply have been way above the 4.5% target, they might as well do away with it. There's no sense in having a formal target if you're just going to ignore it.

But really, money supply is important and should in fact be the primary consideration of central banks -as long as central banks exist, which they really shouldn't. That is not because money supply is a good leading indicator of consumer price inflation. Anyone studying statistics over money supply and consumer price inflation can see that at least in the short- to medium term, money supply growth have virtually no relation to consumer price inflation (with the exception of economies with hyper inflation). But looking at a longer term perspective, the link is stronger, at least if you adjust for real economic growth. And more importantly, even if it doesn't raise consumer prices, it often have the effect of raising asset prices and creating asset price bubbles, something which is just as bad as consumer price inflation.


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