Thursday, December 31, 2009

Is Euro Area Money Supply Rising Or Falling?

The latest euro area money supply figures showed that annual growth of the ultra-broad M3 aggregate turned negative in December (-0.2%, from 0.3% in October), causing for example Ambrose Evans-Pritchard to again complain about the "restrictive policies" of the ECB.

Yet the M3 aggregate makes little sense as a money supply measure, at least in Europe, as it includes for example debt securities with a maturity of up to 2 years. Holders of such securities cannot use it as a means of exchange so it is not money. It is true that such securities are liquid assets in the sense that they can relatively easily and quickly be sold for money, but that is true of company stocks as well, and surely stocks shouldn't be regarded as money.

Money supply should only include assets which can be used as a means of exchange, and in Europe M1 is the aggregate that best captures that. M1 includes currency in circulation and "overnight deposits", which includes both what in America would be called "demand deposits" and "savings deposits".

And M1 is growing at a very rapid pace, 12.6%, in the euro area, suggesting that both growth and price inflation is likely to continue to increase.