With further bad news on the global economy in the past week – US consumer confidence slumped to its lowest level since April 2009, and Asian growth data have been disappointing – calls for policymakers to do something are growing. But, as economists debate how much weight to put on the signs of faltering activity, another set of data are warning that it may already be too late.
Monetary aggregates aren’t the sexiest economic numbers around. Unlike unemployment figures, which relate pretty closely to actual experience, broad money or M4 growth is rather more opaque. Technically, aggregate M4 is a broad measure of the UK money supply. It includes sterling notes and coin, sterling deposits, commercial paper and bonds, claims from repurchase operations (repos), and bank bills. Essentially, it represents the money claims that UK households and businesses have on their banks. M4 Lending, meanwhile, is a measure of banks’ sterling lending to the UK private sector. As banks’ assets and liabilities have to add up across the balance sheet as a whole, a whole host of other factors, including foreign currency assets and liabilities and banks’ public sector dealings, make up the difference.
Historically, monetary aggregates have had a chequered history in UK economic policymaking. In the 1980s, monetary aggregates were famously used as a basis for controlling inflation. The experiment ultimately failed, not least because the precise relationship between monetary data and inflation is far from exact. As a consequence, more recently economists have tended to use money data as a cross-check on medium-term trends and forecasts for the economy, or even over far longer periods of 8 years or more.
Differences between eight-year trends are clearly not that useful when you are trying to forecast the economy over the next year or two. But some policymakers still put significant weight on money data. Technically, the ECB’s second pillar focuses precisely on monetary developments. And as recently as September 2009, when discussing the likely outcome and impact of quantitative easing, BoE Governor Mervyn King said that in order to get steady GDP growth (with low inflation), broad money growth would probably need to be somewhere between 6% and 9%.
Unfortunately, money growth hasn’t done that at all. After peaking at over 17% in 2009, annual M4 growth has been in negative territory since October last year. The Bank of England likes to strip out ‘intermediate other financial corporations’ (IOFCs) from the data, as these institutions can drive large swings in the figures that are not particularly relevant for economic developments. But even after this, annual M4 growth was just 2.2% in July 2011, and M4 Lending was negative. Given that broad money velocity has been falling for at least thirty years, underlying nominal GDP growth is probably even weaker – possibly even zero. And zero nominal growth, with above-target inflation, implies that the real economy may already be shrinking again.
We have yet to see this in the official statistics, although some surveys are entirely consistent with this picture. In part, this could reflect the various special factors that have buffeted the UK economy in recent quarters. Yet, at the same time, it is worth bearing in mind that the relationship between money data and economic activity is pretty weak. However, the message from the former, on Governor King’s own metric, is that the UK really could be on the brink of a double-dip recession. Policymakers need to act fast.