Friday, September 21, 2007

Much Ado about the Money Supply

Barry Ritholtz at the Big Picture takes a look at the MZM money supply and Fed liquidity action and concludes " that the Fed is 'inflating' at a rate faster today than it did right after 9/11, or during the deflationary scare of 2003." Barry, therefore, is concerned about the 50 bps rate cut and the signal it sent the markets. He concludes that a collapsing dollar, soaring commodity prices, and creeping inflation can be expected. Michael Shedlock of Mish, on the other hand, examines the more narrow monetary base and concludes the Fed is not "printing money like mad."

So there is some debate on what these monetary aggregates mean for the future. What do they tell us about the past? In particular, what do they say about how we got here? Below is a figure that plots the ratio of MZM to industrial production, a monthly proxy for real economic activity. The series is normalized to 100 in 1959.

The figure shows above-trend levels in the series over 2001-2005. This is what I have called in past blogs the past monetary profligacy of the Fed. To be fair, though, this spurt could have been endogenously generated from strong money demand growth that in turn drove central bank actions. The question then is whether any of this growth was the result of exogenous central bank decision making.

Update I:
In the comments section, JMK makes an interesting observation on the above graph: there is no trend up through the late 1970s, the very period that inflationary pressures were building. I am not sure I have a satisfactory answer to this puzzle, but I did go ahead and graph the MZM velocity for the above time period. The graph was created using the MV=PY identity along with MZM money supply, industrial production, and the CPI (i.e. V=[PY]/M). This figure is below and shows an upward trend in velocity during the period in question. It is also interesting to see velocity relativey stable thereafter until about the 2000s.
Update II:
Above I plotted the ratio of MZM, a nominal variable, to the industrial production index, a real variable. Below I plot the ratio of MZM to the industrial production times the CPI. This ratio, therefore, is a nominal variable to a nominal variable. The Results are interesting.

(Blogger won't let me load up pictures tonight so click here to see the graph)


  1. Curious that MZM/IP is trendless from 1959-1977 - the very era when inflation was on a rising trend ?

  2. Good question JMK. I am curious and will look into it. The only thought that comes to mind is velocity.