Pre-Crisis, World Bank Data Shows That Iceland Grew Its Money Supply 5.4 Times Faster Than Its GDP Growth! Spain 4.9 Times! The U.K 4.4 Times! The U.S. 3.3 Times! What Were Central Bankers Thinking?

Excerpt From http://federalreserve.gov/faqs/money_12845.htm

“What is the money supply? Is it important?”

“There are several standard measures of the money supply, including the monetary bases, M1, and M2. Over some periods, measures of the money supply have exhibited fairly close relationships with important economic variables such as nominal gross domestic product (GDP) and the price level. Based partly on these relationships, some economists….Milton Friedman being the most famous example….have argued that the money supply provides important information about the near-term course for the economy and determines the level of prices and inflation in the long run. Central banks, including the Federal Reserve, have at times used measures of the money supply as an important guide in the conduct of monetary policy. Over recent decades, however, the relationship between the various measures of the money supply and variables such as GDP growth and inflation have been quite unstable. As a result, the importance of the money supply as a guide for the conduct of monetary policy in the United States has diminished over time.”

Key Excerpts From Milton Friedman’s “The Role of Monetary Policy”, Refute The Fed’s Current Position Re. The Money Supply:

 “How should monetary policy be conducted? The first requirement is that the monetary authority should guide itself by magnitudes that it can control, not by ones that it cannot control. If, as the authority has often done, it takes interest rates or the current unemployment percentage as the immediate criterion of policy, it will be like a space vehicle that has taken a fix on the wrong star. No matter how sensitive and sophisticated its guiding apparatus, the space vehicle will go astray. And so will the monetary authority.”

“Attempting to control directly the price level is therefore likely to make monetary policy itself a source of economic disturbance because of false stops and starts.”

“Perhaps, as our understanding of monetary phenomena advances, the situation will change. But at the present stage of our understanding, the long way around seems the surer way to our objective. Accordingly, I believe that a monetary total (the money supply) is the best currently available immediate guide or criterion for monetary policy..”

“..My own prescription is still that the monetary authority go all the way in avoiding such swings by adopting publicly the policy of achieving a steady rate of growth in a specified monetary (money supply) total.”

“It is a matter of record that periods of relative stability in the rate of monetary growth (in the money supply) have also been periods of relative stability in economic activity, both in the United States and other countries. Periods of wide swings in the rate of monetary growth have also been periods of wide swings in economic activity.”

“By setting itself a steady course and keeping to it, the monetary authority could make a major contribution to promoting economic stability. By making that course one of steady but moderate growth in the quantity of money, it would make a major contribution to avoidance of either inflation or deflation of prices.”

“…steady monetary growth would provide a monetary climate favorable to the effective operation of those basic forces of enterprise, ingenuity, invention, hard work, and thrift that are the true springs of economic growth.”

Comments from Mike Perry, former Chairman and CEO, IndyMac Bank:

I am not an economist, but I don’t think the Fed statement above is correct. I think the Fed and other central banks have made a big mistake by ignoring Nobel laureate and monetary expert Milton Friedman’s views and advice about the money supply being paramount. Mr. Friedman makes clear that you can’t peg rates or unemployment using monetary policy; and in fact, I would argue that inflation is not really being properly measured, because it excludes real estate, bonds, and stock prices; so controlling the supply of money is more important than ever. (See Statement #74 on this blog, where Mr. Friedman’s 1967 speech, “The Role of Monetary Policy” is provided and discussed. Also Statement #76 addresses the importance of the money supply.) For some reason, the Fed stopped publishing M3 in 2006, the widest and I believe most important measure of the money supply. I may be wrong but it seems to me it is important to have the widest possible measure of the money supply, because of the massive increase in non-bank credit (mutual funds, mortgage reits, securitization, derivatives, etc.) over the past few decades. By the way, I saw Ron Paul on CNBC recently complaining about this very issue (M3). That being said, I was able to dig up historical data from 2000 to 2012 for M2 from The World Bank and I think even this more narrow measure of the money supply, shows that a lot of the countries that got in to trouble during the 2007-2009 financial crisis (including the United States), where the ones whose central bankers increased the money supply at a much more rapid rate than annual GDP growth. Excessive growth in the money supply and very low interest rates; monetary policies conducted by our Fed and other central bankers was the primary cause of the global financial crisis, in my opinion.

From The World Bank’s Money and Quasi-Money (M2) and GDP Historical Data:

(M2 and GDP Simple Average Annual Growth Rates in Select Countries)

Greece M2

2002 to 2008: +9.1% (+3.5% GDP growth, M2 growth was 2.6 times GDP growth)

2009 to 2012: -6.2% (-5.4% GDP growth)

Iceland M2

2000 to 2008: +22.6% (+4.2% GDP growth, M2 growth was 5.4 times GDP growth)

2009 to 2012: -2.9% (-1.6% GDP growth)

Ireland M2

2000 to 2007: +21% (+5.1% GDP growth, M2 growth was 4.1 times GDP growth)

2008 to 2012: -9.6% (-1.2% GDP growth)

Spain M2

2000 to 2008: +16.1% (+3.3% GDP growth, M2 growth was 4.9 times GDP growth)

2009 to 2012: -1.3% (-1.2% GDP growth)

United Kingdom M2

2000 to 2008: +11.8% (+2.7% GDP growth, M2 growth was 4.4 times GDP growth)

2009 to 2012: +0.1% (-0.2% GDP growth)

United States M2

2000 to 2008: +7.5% (+2.3% GDP growth, M2 growth was 3.3 times GDP growth)

2009 to 2012: +3.3% (+0.8% GDP growth, M2 growth was 4.1 times GDP growth)

Germany M2

2000 to 2008: +3.7% (+1.6% GDP growth, M2 growth was 2.3 times GDP growth)

2009 to 2012: +0.3% (+0.7% GDP growth, M2 growth was 0.4 times GDP growth)

Japan M2

2000 to 2008: -1.4% (+1.2% GDP growth, M2 growth was negative)

2009 to 2012: +2.3% (+0.1% GDP growth)

China M2

2000 to 2008: +16.4% (+10.4% GDP growth, M2 growth was 1.6 times GDP growth)

2009 to 2012: +19.8% (+9.2% GDP growth, M2 growth was 2.2 times GDP growth)

Posted on November 6, 2013, in Postings. Bookmark the permalink. Leave a comment.

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