Economics Weekly - Weak money supply growth argues for continued stimulus; Weekly economic data preview -UK poised to exit recession in Q4, while US recovery gathers further momentum
Economics Weekly -25 January 2010
Weak money supply growth argues for
A notable feature of the global economic
downturn over the past two years has been the marked weakening in money supply
growth. Despite unprecedented policy stimulus, the deposits held by the private
sector and the amount of bank borrowing undertaken have both slowed sharply.
Since peaking at 9.6% in early 2008, OECD annual broad money supply growth has
almost halved to 5.4%. As chart a shows, broad money supply in the US, euro
zone and UK have all posted sharp slowdowns over
the past year, with the annual growth of broad money (M3) in the euro zone
recently dipping into negative territory for the first time ever.
The desire of monetary financial
institutions to repair their balance sheets has led to a decline in the supply
of credit, while uncertainty over the economic outlook has weakened demand for loans.
The fall in both the supply of, and demand for, credit has contributed to a
decline in the money multiplier - how quickly financial intermediaries convert
deposits into new lending - and the velocity of money â€“ how many times money is
spent in the economy. These declines, in turn, have exacerbated the fall in
both money supply and nominal spending growth.
That said, there is no clear hard and
fast short-term relationship between the money supply and nominal gdp growth.
As chart b shows, there was a clear breakdown in the link between UK broad money growth (M4) and nominal gdp
from the early to mid-1990s. The breakdown in this relationship, which was also
evident in other countries, was largely due to the increased instability of the
velocity of money. This was partly related to the growth of debit card
transactions and also to changes in the structure of financial intermediation,
notably the growth of off-balance sheet vehicles and the increase in capital
market funding. The impact of these changes has been to weaken the link between
traditional forms of credit growth and nominal spending.
As a result, the importance central
banks attach to money supply developments in setting
monetary policy has declined since the
1980s. Nonetheless, the relationship may be inexact, but money supply trends
can still impart useful information about the prospects for an economy. For example, the
contraction in the euro zone money supply strongly suggests that nominal gdp
growth across the region is likely to remain weak for some time.
More generally, with the worldâ€™s central
banks having embarked on an unprecedented loosening of monetary policy, money
supply is once again being monitored for signs of whether the policy stimulus
is working. This is particularly the case in the UK, where the Bank of England has gone a
step further than most other central banks by injecting around Â£200bn into the economy
through the purchase of financialassets
(mostly gilts) from the private sector. These purchases have been financed
through the creation of central bank reserves (the so-called policy of
The Bank of England hoped that these
purchases would achieve two aims: (i) boost financial asset prices, both gilts,
equities and corporate bonds, and thus boost financial and economic confidence;
and (ii) by raising the aggregate amount of deposits and reserves held in the banking
system, encourage an increase in bank lending, thus raising money supply growth
and, with a lag, nominal spending.
So far, evidence of the success of this
policy has been mixed. While Quantitative Easing appears to have boosted
financial asset prices â€“ equities have risen sharply and corporate bond spreads
have narrowed â€“ traditional credit growth and nominal gdp growth have fallen
further. As chart b shows, both the headline annual rates of broad money (M4)
and nominal gdp growth have continued to drop sharply over the past year.
The detail of the money supply data
shows an even weaker prognosis. Transfers between banks and intermediate â€˜other
financial companiesâ€™ have grown substantially over the past ten years. These
flows, which are captured within the OFCs component of M4, impart little information about trends in nominal
spending. To get a better picture of underlying trends, the Bank of England is
now publishing a measure of M4 which excludes intermediate OFCs. As chart
c shows, on this measure, annual M4 growth
has dropped from over 10% to less than 3% over the past two years, while M4
lending (ex OFCs) has fallen from a peak of over 14% to just 0.1%.
The weakness of money supply growth is
partly being driven by the desire of both households and companies to pay down
their loans. Over the past year, the amount of outstanding borrowing from banks
and building societies by households and private non-financial companies
(PNFCs) has declined by 0.8% and 2.4%, respectively (i.e. debt has been
repaid). The rate of borrowing for house purchase has slowed markedly, while
consumers have reduced their unsecured balances. Faced with historically high
levels of indebtedness and a weak labour market, this process of balance sheet
repair in the household sector is likely to continue.
In the corporate sector, the picture is
more complicated. While PNFCs have paid down bank debt over the past year, thus
reducing M4, the volume of bond and equity issuance has picked up markedly (see
chart d). Indeed, it appears that larger companies are actively using the proceeds
of capital market financing to reduce their outstanding bank loans.
With households and companies likely to continue
repairing their balance sheets, the prospect of a meaningful recovery in money supply
growth in the UK and other developed economies remains
remote. Although there is no automatic link between money supply and nominal
GDP, a recovery in money growth (towards a more normal range of around 5-7%) is
likely to be viewed by policy makers as an important objective as they seek to
put nominal gdp growth on a firmer footing. Indeed, until measures of money
supply start to turn higher, speculation of a reversal, or even a suspension, of
policy stimulus in the UK, US or euro zone may well be premature.
Adam Chester, Senior UK Macroeconomist
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Weekly economic data preview -25 January 2010
UK poised to exit recession in Q4,
while US recovery gathers further momentum
ô€‚„ Financial markets will have to wait until Friday for the data
highlight of the week in the US. The advance estimate of Q4 2009 GDP is
expected to show economic activity picked up sharply, after belatedly returning
to positive territory in Q3. We look for annualised GDP growth of 5%, underpinned
by consumer spending and a strong contribution from inventories. Figures for
December durable goods orders will be closely watched on Thursday, for clues
about business investment trends and to help refine Q4 GDP forecasts.
Meanwhile, we expect another contrasting performance from existing and new home
sales in December, primarily highlighting the important influence of government
initiatives at this time. We expect existing home sales to have declined
sharply to 6.0mn (from 6.54mn), but new home sales to have rebounded to 380k
(355k). Consumer confidence will be a key determinant of economic prospects -
and the housing market â€“ over the year ahead. We look for a third successive
rise in the Conference Boardâ€™s headline index to 53.5 (from 52.9) on Tuesday,
while the University of Michigan sentiment index may be revised up to 73.5
(72.8) in January on Friday.
Although the FOMC is widely expected to
announce another unanimous decision to keep the target range for the Fed funds
rate at 0-0.25% on Wednesday, financial markets will be alert to any changes to
other emergency programmes or in the language used in the accompanying press
statement. It is also a heavy week for Treasury issuance ($118bn).
ô€‚„ It is a light week for UK data, but still an important one. The
first estimate of Q4 GDP (Tuesday) will be the one of the last key data points
for the MPC to evaluate before going into its Inflation Report forecasting
round (sectoral M4 data released on 1 February will also be of importance to
gauge the recent efficacy of the quantitative easing programme). The decision
on whether or not to extend the Asset Purchase Facility at the February meeting
hangs in the balance and so the detail of the GDP report will be important for
marginal voters on the MPC. Our central view, which is predicated, in part, on
survey evidence (including our own business barometer) is for a relatively
modest 0.4% quarterly expansion, marking the first positive reading in seven
quarters. There is also some consumer-related data to digest, with the confidence
index (Friday) expected to rise slightly reflecting in part, early signs of an
improvement in the labour market. To the extent that retail sales growth was
boosted in December by an advancement of consumption ahead of the VAT rise at
the turn of the year, a fall in the CBIâ€™s reported retail sales balance for
January (Wednesday) is forecast, as this effect washes through the data. The
inclement weather conditions earlier this month are also likely to have
depressed retail activity. Housing data on both prices and bank mortgage
approvals are also released during the week.
ô€‚„ From a financial markets perspective, the euroâ€™s price action will
be closely watched as concerns about public finances in peripheral euro-zone
countries continue to mount. In terms of data, this week sees a further round
of euro-zone business surveys. The main highlight will be Tuesdayâ€™s German Ifo
report, where we anticipate an improvement in the business climate index to
95.0 in January, from 94.7. Broadly, the underlying picture in Germany is one of healthy current economic
sentiment supported by tax cuts to boost economic activity, with expectations
relatively less upbeat. The latter reflects concerns over the sustainability of
global recovery (vital for Germanyâ€™s exports) and also the eventual withdrawal
of government labour market subsidies (which potentially presage a sharp rise
in unemployment). Meanwhile, weakness in the broad euro-zone monetary
aggregates underscore the ECBâ€™s cautious stance on unwinding past monetary
stimulus. We look for M3 to contract by some 0.5% in the year to December, with
loans to the private sector falling by 0.9% over the same period. Lending to
the non-financial sector has been pared back particularly sharply. Finally,
Januaryâ€™s euro-zone CPI estimate is published on Friday, where our forecast
stands at 1.1% year-on-year.
Jeavon Lolay (Senior Global
Macroeconomist), George Johns (UK Macroeconomist), Mark Miller (Global
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