Tuesday, August 07, 2007

M3 Money Supply

Since the Federal Reserve Board has stated that they will no longer measure and release the numbers calculated for M3, blogs and the internet have come up with a number of conspiracies or cover ups. First let me identify what Money supply is.
United States
Components of US money supply (M1, M2, and M3) since 1959
Components of US money supply (M1, M2, and M3) since 1959

The most common measures are named M0 (narrowest), M1, M2, and M3. In the United States they are defined by the Federal Reserve as follows:

* M0: The total of all physical currency, plus accounts at the central bank that can be exchanged for physical currency.
* M1: M0 - those portions of M0 held as reserves or vault cash + the amount in demand accounts ("checking" or "current" accounts).
* M2: M1 + most savings accounts, money market accounts, small denomination time deposits and certificate of deposit accounts (CDs) of under $100,000.
* M3: M2 + all other CDs, deposits of eurodollars and repurchase agreements.

As of March 23, 2006, information regarding M3 will no longer be published by the Federal Reserve, ostensibly because it costs a lot to collect the data but doesn't provide significantly useful data[1]. The other three money supply measures will continue to be provided in detail.
In an effort to reverse this change, Congressman Ron Paul introduced the now expired H.R.4892[2] on March 7th, 2006, and subsequently sponsored H.R.2754[3][4] on June 15th, 2007 which has been referred to the House Committee on Financial Services.

So the M3 is made up of Eurodollars that do not influence the Money Supply since it tends to be just circular financial dealings. It was a rise as a result of the over-regulation arising from Regulation Q. And the same with repurchase agreements for short durations of bank transfer of debt instruments-it also rose out of regulations. And lastly large CDs that do not turn over much.

I also saw this and corresponds with my friend asking about UK money supply issues:
United Kingdom

There are just two official UK measures. M0 is referred to as the "wide monetary base" or "narrow money" and M4 is referred to as "broad money" or simply "the money supply".

* M0: Cash outside Bank of England + Banks' operational deposits with Bank of England.
* M4: Cash outside banks (ie. in circulation with the public and non-bank firms) + private-sector retail bank and building society deposits + Private-sector wholesale bank and building society deposits and CDs.v

Interesting, seems that it was cut off and this break down is kind of strange.

So let me try and answer these questions from a friend:
Last spring the Fed mysteriously stopped publishing the M3 money supply numbers. Why do you suppose that is?

Bad news about the economy? debt owed for foreign borrowing?

I guess the first thing to do is to see what the Federal Reserves says about the changes (Discontinuance of M3).
M3 does not appear to convey any additional information about economic activity that is not already embodied in M2 and has not played a role in the monetary policy process for many years. Consequently, the Board judged that the costs of collecting the underlying data and publishing M3 outweigh the benefits.

So what is the purpose of monetary policy by the Fed?
The goals of monetary policy are spelled out in the Federal Reserve Act, which specifies that the Board of Governors and the Federal Open Market Committee should seek “to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates.” Stable prices in the long run are a precondition for maximum sustainable output growth and employment as well as moderate long-term interest rates. When prices are stable and believed likely to remain so, the prices of goods, services, materials, and labor are undistorted by inflation and serve as clearer signals and guides to the efficient allocation of resources and thus contribute to higher standards of living. Moreover, stable prices foster saving and capital formation, because when the risk of erosion of asset values resulting from inflation—and the need to guard against such losses—are minimized, households are encouraged to save more and businesses are encouraged to invest more. The Federal Reserve System/Purposes and Functions (PDF)

The link was the complete publication but can be downloaded by chapters at The Federal Reserve System.
While the Fed has a diverse set of goals, it is easy to see that money supply has no direct affect on the accomplishment of full employment and moderate long-term interest rates. The later is controlled more by expectations than by inflation and then less by fluctuations of money supply.

Now let me have some Economists or others informed on this issue to bring some light to these issues. The blog post Alex, I’ll take esoteric economic indicators for $100: is very informative. Let me just highlight some major points:
1. "The Fed will still report the individual components, and so anyone who wants to can (painstakingly) reassemble this into their own M3" And I saw one person getting a rough approximation at M3 b, repos & Fed watching.
2. Most of hubbub is along the lines of conspiracy theories.
3. "Spencer England of SEER noted that MZM may be a more useful measure of Money Supply, ever since the relationship between M1 + M3 and the markets broke down."
4. "Oregon Economics Professor Mark Thoma noted that having M3 available makes it easier to track movements “into and out of M1 and M2 over time.”
5. And lastly questioned the actual costs.

From: Is M3 1 really gone?

Institutional Economics has some important points in their posts starting with: What Do Money and Credit Aggregates Really Tell Us? in where he describes tin foil hat brigade and fever-swamp Austrians.
I’m much more sympathetic than most economists to the idea that money matters. Base money arguably has a neglected role in monetary policy transmission that is independent of the official interest rate and some of that role may also be reflected in broad money aggregates. However, it is mistake to interpret broad money and credit aggregates as being predominantly a function of exogenous monetary policy decisions. They have a much stronger relationship with individual portfolio choices and innovations in financial technology, in other words, capitalist acts between consenting adults. When the fever-swamp Austrians point to growth in these aggregates as being symptomatic of the supposed monetary depredations of the Fed, they are inadvertently condemning what are largely market-determined outcomes in relation to financial intermediation.

Why there is No Money in Monetary Policy
However, this is a far cry from saying that one can simply read-off from growth rates in money and credit that the stance of monetary policy is too loose or too tight, based on some a priori view of what constitutes reasonable growth rates in these aggregates. The people most inclined to do this are the fever-swamp Austrians, who argue that every tick in the business cycle must be attributable to a fiat money supply error on the part of the Fed. These are the same people who argue that money demand is too complex a phenomenon for the Fed to be able to calibrate an appropriate growth rate in the money supply. That is perfectly true, which is why the Fed doesn’t even try. Yet the fever-swamp Austrians are implicitly claiming enough knowledge about money demand to determine whether monetary policy is too loose or too tight, just by observing simple growth rates in money, credit and even asset prices. This is what Hayek would term a ‘fatal conceit’ and is a travesty of Austrian economics.

IE also have another post that links to: M3 or not M3? at Econobrowser.
I have to confess that in a quarter century of teaching and research, I never had any occasion to make use of M3. It always seemed to me that this unambiguously failed the definition of an asset that is used to pay for transactions. If you’re going to include such assets in your concept of “money”, why stop there? Don’t you want to include T-bills as well, and if them, why not Treasury bonds? You have to stop somewhere, and I always stopped with M1 or M2.

In addition, a primary reason for focusing on the money supply for policy purposes is that it’s a magnitude controlled by the government. The physical dollar bills are of course printed by the government, and a bank that issues checking accounts must hold credits that could be used to obtain physical dollars (known as Federal Reserve deposits) in a certain proportion to the value of the outstanding checkable deposits. However, it is unclear how the government is supposed to control the M3 components. Balances at foreign banks, for example, are clearly outside the control of the U.S. government.

I was thus a bit surprised at the brou-ha-ha that erupted over the Fed’s decision to discontinue requiring banks to provide the data that was used to calculate some components of M3. These concerns continue to bubble up in comments from Econbrowser readers.

I’m aware of no evidence suggesting that M3 helps predict U.S. inflation or economic activity better than M2.

Well if I have not bored everyone yet...

Note Links (may already be used above or dead):
Money Supply and the End of M3

The American Banking Monopoly ___how it steals your savings!

GDP Up 4.2% in Third Quarter

How Banking (and the World) Really Works

Why there is no Money in Monetary Policy

Fed kills a key inflation gauge

Federal Rerserve Statistical Review/Money Stock Measures

Id Monsters, Self-Deceptions, and $1,000 Gold - Part III A

US M3 Growth Rising In Line With Oil Prices

M3 Revisited

Unpleasant Trend - Fed Counters By Stopping Release of M3 Money Supply Data

M3 b, repos & Fed watching

Update (3-31-08):
"Anonymous" decided to grace my blog with his/her presence by providing the following passage.
You're a total hack. See here for the real, unobfuscated and distorted story on why the gov is hiding M3: http://www.shout.net/~bigred/HouseOfCards.html
M3 is the measure that shows the fastest growth in the money supply.
I'd certainly agree that a measure of the money supply like M3, which combines M1 (currency in circulation, commercial bank demand deposits, automatic transfers from savings accounts, savings-bank demand deposits and travelers checks) with M2 (overnight repurchase agreements between banks, overnight eurodollars, savings accounts, CDs under $100,000 and money market shares) is woefully inadequate in an age when securitizations of mortgages and other debt instruments, the debits and credits of the international carry trade in currencies and the vast derivative markets can add hundreds of billions of global liquidity in a matter of hours.

Because it's so hard to say exactly what money is today, a measure like M3 does seem antiquated.
Rather than killing off M3, you'd think the Federal Reserve would be spending money to develop and publish data for an M4 and maybe an M5 to track the ebbs and flows of an even-more-expansive definition of money that includes some of the new forms of money that have been manufactured on Wall Street and in other global banking sectors.

But that makes it even odder, in my opinion, that the Federal Reserve would decide to kill off M3, the most inclusive of current money-supply measures, yet keep collecting the data for narrower definitions of money such as M1 and M2.
Let me first say, of course I am a hack. I claim nothing more than a "Pseudo Economist" status.

But this is of little value what anonymous offers. When judging inflation we need to be only concerned with "transaction money", not quasi money. If he thinks we need to have broader and broader definitions then why not count wealth? I mean in a way all equities is a form of "money" that can be traded fairly easily also. Thus they collect the data for types of money that actually relate to their mandate to regulate and control inflation.


Saturday, August 04, 2007


8. In the light of a theory of capital flight from less developed countries, discuss policies that could reverse it.
Khan, M.S. and N.UI Haque (1985) 'Foreign Borrowing and Capital Flight: a Formal Analysis', IMF Staff Papers, vol 32, no 4 December
Policy problems:
a. Debt overhang
b. Dual exchange rates causes a problem since most models are based on one exchange rate instead of one for transaction on the current account of the balance of payments (the commercial rate) and the one for capital account transactions (the financial rate).
c. Parallel Foreign Exchange Markets is the results of having ‘unofficial rates’ as well ‘black markets’.
d. Currency Substitution is when residents of a country uses currency of another country (e.g. Israel and Mexico during the 1980’s). Should have led to a North America Union.

Possible solutions:
Tobin Tax
Multiple Exchange Rates
Raising Interest Rates and eliminating Financial Repression
Formation of stable Fiscal and Monetary policies over the long term. Short term flight may derive from instability over long periods.
Non-discriminatory towards domestic savings.
Capital controls for the short-term period.
Measuring the Two or Three Gap models and determining if Capital Flight is a problem or may just be Capital Allocations across countries to diversify risks.
Avoiding the government making implicit or explicit guarantees to foreign investment-especially if denominated in foreign currencies. Thus avoid Moral Hazards created by guaranteeing capital coming into the country.
Obviously, providing a stable financial and macroeconomic environment would go a long way toward reducing domestic uncertainty. The experiences of the major debtor countries show that capital flight was most pronounced in those countries that had relatively higher and more variable rates of inflation, larger fiscal deficits, and overvalued currencies.

"Full compensation of domestic investors in the event of government expropriation". But this opens a variety of other questions about when is it 'expropriation'.
Expanding the menu of financial instruments or more broadly increasing investment opportunities domestically-depth and width.
Dooley, M.P. (1988) 'Capital Flight: a Response to Differences in Financial Risks', IMF Staff Papers, vol 35, no 3 September
For the purposes of this paper, flight capital is defined as the stock of claims on nonresidents that do not generate investment income receipts in the creditor country's balance of payments data.

...external criditors may have access to explicit or implicit government guarantees not available to residents. In this case the capital outflow to avoid the inflation tax would be matched by a capital inflow that is protected from the inflation tax because of its currency denomination and that also enjoys a government guarantee.

Exactly as said earlier. Moral hazards are insured by the government for foreign investments but not domestic. Factors of Capital Flight:
Domestic Inflation
Financial Repression
Risk Premium
Political Risk Premium

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