An AB reader emailed me a blog post called The Return of M3:
This broadest of money supply measures had shown a discomforting increase in liquidity, far greater than what M2 was revealing. At the time of the M3 announcement, we suspected the Fed was attempting to cover their tracks, disguising an ongoing increase in money supply and an unstated “easing” in Fed bias.
The first link in this “HOA Nut House” post provides links to all sorts of blog discussions about the decision by the March 2006 Federal Reserve decision to discontinue this series. Not being a fixed velocity monetarist, I guess I am guilty of not paying much attention to these discussions. But I was curious as to what kind of signals one would get as to monetary policy had one been tracking M1 v. M2 v. M3 since the beginning of this century.
It seems until 2005, the signals would not have been that different. During 2001, the money supply growth was close to 10% regardless of which measure one used and with nominal GDP growing by only 2.74%, the velocity of money fell. None of this would be a surprise to us IS-LM Keynesian types given the investment led (read downward shift of the IS curve) recession. It is also fortunate that the Federal Reserve decided to increase the growth rate of the money supply.
For the 2002 to 2004 period, monetary growth slowed a bit and approximated the growth rate of nominal GDP. In other words, velocity neither returned to its former level nor fell by any appreciable amount – regardless of which measure of the money supply one used.
During 2005, however, M1 did not rise even as nominal GDP growth exceeded 6%. M2 growth was 3.9%, which mean its velocity rose a bit as the velocity of M1 rose significantly. The velocity of M3, however, fell as M3 grew by 7.8%. For the fixed velocity monetarism types, I guess there should be a debate as to what all of this means in terms of which monetary aggregate is the most reliable. But again – I’m not a fixed velocity monetarist. Besides, I’m still hoping that the Federal Reserve lowers interest rate a bit.