The Money Supply Definition Issue Revisited

I recently explained why Frank Shostak's narrow definition of money is false and why his arguments for it are of really poor quality. I won't repeat this now so in case you forgotten about it or didn't read it, follow the link.

Two famous Austrian-leaning economists who have fallen for Shostak's nonsense are Mike Shedlock and Gary North. Mike Shedlock basically repeated Shostak's false claim that some forms of money should be viewed as credit transactions rather tha money plus arguing that it better predicted recessions. In the linked post, I explained why that argument was false too.

Gary North today on LRC linked to a paper written by himself where he argued M1 -the official money supply measure most similar to Shostak's- is better than broader measures like M2,MZM and M3.

His argument is actually worse than Shostak's. He rejects on account of being the money supply measure increasing in the long run most similar to the CPI. This is so unbelievably nonsensical. Even setting aside the usual Austrian objections to this Friedmanite approach, there is no reason theoretically to expect the money supply to follow the CPI even in the long run and even assuming the CPI correctly measure true consumer price inflation. This is first of all because shifts in asset values relative to GDP can mean that money supply can increase faster or slower than the value of production. And secondly and even more importantly, money prices of goods and services do not just -I can't believe I have to explain this to someone considering himself an economist- depend on the money supply but also the supply of goods and services. If the supply of goods and services increase, then the CPI will of course even in the long run increase a lot slower than the money supply.

The most relevant number to compare the money supply would actually be nominal GDP. And the money supply measure most closely tracking that would be M2 or M3. Nominal GDP between 1985 and 2005 -fourth quarters for GDP, December for money supply, the reason why 2005 is the last year is because that was the last year M3 was published- increased by a factor of 2.95, whereas M2 increased by a factor of 2.7 and M3 by a factor of 3.15. M1 strongly undershot it by increasing by a factor of just 2.2. MZM on the other hand strongly overshot it by increasing a full 4.1.

However, to the extent we should expect some under- or overshooting of nominal GDP, that would be overshooting it. The reason is that asset values have increased far faster than nominal GDP, with both stock- and house markets being far, far higher valued relative to GDP in 2005 than 1985. This means that either M3 or MZM should be considered the money supply measure most closely tracking economic activity. And since M3 has been "discontinued" by the Fed, this means MZM in practice for us.M2 is less useful, while M1 -as well as Shostak's closely related measure- should be considered completely useless.

0 comments to “The Money Supply Definition Issue Revisited”

Leave a comment on: The Money Supply Definition Issue Revisited

Cool Followers

Popular entries

 

Economic times The Money Supply Definition Issue Revisited © 2012 Info recommended by: Global economics online