Tuesday, March 18, 2008

MZM Outside America

I have discussed the issue of the definition of the money supply several times (see here, here and here), usually focusing on the American money supply definition and usually with the advocates of Frank Shostak's very narrow definition. Instead, I have argued that the money supply definition known as MZM (Money of Zero Maturity)is the best. In America there is no doubt as to what MZM consist of and it is even published by the St. Louis Fed.

The problem is that in other countries, this definition is not available. And the definition of what constitutes M1, M2 and M3 usually differ between different countries. So instead most people (including until recently me)uses M3 as the best broad money supply definition for all countries. Yet I have recently reconsidered this. When preparing a report for Swedish free market think tank Timbro about Swedish monetary policy which will soon be released (Unfortunately for my non-Swedish readers, it will be in Swedish), I started to actually look at what the different money supply measures included. And it became immediately clear to me that M3 is too broad. M3 included for example interest-bearing securities held by the Swedish public with a maturity of up to two years. A two-year bond could hardly be considered money in my view, as it implies that the holder of it has given up the money invested in it for two years, unless he can find someone else willing to take over that commitment by buying the bond. And the same thing really goes for 1-year bonds and treasury bills. Of the non-M2 M3 items, only money market fund holdings can be considered money. Non-M1 M2 is more unclear since it seems to package together without any subdivision both saving deposits (which should be considered money) and genuine time deposits (which should not be considered money). Still, overall M2 seemed like the best of the three M's. Note that this applies to the euro area too as the Swedish definition is explicitly harmonized with the one used by the ECB.

What this reminds us of is that money supply definitions can be too broad as well as too narrow. And I suspect that M3 is too broad in many other countries as well. In New Zealand for example M3 explicitly includes all funding of New Zealand financial institutions, whereas M2 only includes funding that "can of right be broken without break penalties". Although it is unclear what these penalties consist of, it seems clear that we're here talking about time deposits. Similarly, in Australia M3 also includes CDs and other time deposits. However, no M2 seems to be available on the monetary aggregates page of the Reserve Bank of Australia web site, so the best money supply definition seem to be M3 minus time deposits or alternatively M1 plus "other deposits".

This discussion may seem technical, but as the growth of different money supply definitions often differ significantly (In recent years, broader aggregates seem to grow faster in most countries) it is relevant for determining just how strong inflationary pressures from the monetary system is. In the case of New Zealand, we see M2 shrinking by 1.4% while M3 is up 8.9%. In Australia and Sweden all monetary aggregates show significant growth, although M3 is growing significantly faster than the other aggregates in both countries.


Anonymous newson said...

is this a retraction of your previous criticisms of north/shostak/shedlock money definition, which you deemed too narrow?

by the way, do you know who actually dictates the amount of physical currency on issue? is this an entirely discretionary power of the central bank? maybe you could answer for the us and sweden.

one final request for some future piece - what is the interplay between the ecb and the national banks of the emu regarding bank collapses? the national reserve banks supervise prudential standards, but who picks up the tab if a house falls?

4:49 AM  
Anonymous newson said...

oops, should have re-read the article. even the title was enough! so forget my redundant question.

incidentally,there's been a lively blog thread over at mises.org between mike sproul
(real bills doctrine exponent) and the austrians (http://mises.org/story/2901). i'm hostile to the rbd, but they make some interesting points.

5:20 AM  
Anonymous Anonymous said...

I know you prefer MZM but take a look at this crude chart of M1 vs inflation.
It seems whenever 'spendable cash' in checking accounts spikes, there is a delayed inflation effect about 2 years later.


It seems more reliable of an indicator than MZM or M2.
What do you think?

8:23 AM  
Blogger stefankarlsson said...

Anonymous, no I don't think so because even setting aside the problem of having money supply definitions being determined by correlation to some economic statistics (something which would ultimately cause the correlation between money and that statistics to be a tautology), not to mention my problem with the core inflation concept, the chart doesn't really show any particular strong correlation, with for example M1 sharply increasing in the mid-1980s while core inflation falls, and similarly M1 again accelerates in the early 1990s with double digit growth while inflation falls, and then M1 growth collapses to negative numbers in the late 1990s while inflation is roughly unchanged, and so on.

9:50 AM  
Anonymous Anonymous said...

Hi have a good look at the Australian money supply (M3) and you will find that the latest figures (January) shows it growing at 22% yr/yr!!!! Look at the RBAs FX reserves thay've declined from $A84B to $A36B. The Lucky country looks sick, yet they claim inflation is only 3%. If you go to New Zealand a bunch of bananas cost $NZ0.99 (C. American) but in Aust. a bunch costs $A15 and they are the crappy local type. Yet NZers are moving to live in Australia and a rate of 1000 per week. Crazy!!!!

12:51 PM  
Anonymous Anonymous said...

I think you want to define money supply pretty tightly. Cash in the publics hands plus on-call no-penalty substitutes at the bank.

But for what purpose are you wanting to define it for?

Inflationary pressures? You mean consumer price inflation?

Well you cannot predict that readily from money supply data alone and out of context. Because consumer goods are mostly made overseas these days. And because spending on consumer goods is a tiny minority of total spending in the economy.

So in no way could you jack up a simple formula relating any monetary aggregate to consumer price inflation.

But you can most certainly make the link-up between money supply and total spending.

You need more of a narrative then simple correlation is going to give you.

Graeme Bird.

6:33 PM  
Anonymous Mark Smith-Windsor said...

Why do you feel that "money market" would qualify as money but t-bill's wouldn't?

9:45 AM  

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