Does monetary analysis need to extend beyond the aggregates?

Doug Noland:

Years back I became convinced of the unreliability of the monetary aggregates. During the '90s, the evolution of ‘money’ creation and Credit expansion took a giant bound to a much more Wall Street, securities and mortgage centric dynamic. Myriad new types of financial sector debt issuers and Credit instruments - along with novel avenues of financial intermediation - profoundly altered a Credit system previously dominated by bank assets (chiefly loans) and liabilities (largely deposits). Increasingly, it was the aggressive and enterprising “non-banks” dictating the pace and direction of the “flow of finance” throughout the markets and economy.

In the context of this vastly altered financial landscape, the M’s at times provided an acceptably reliable reflection of underlying Credit and economic growth trends. At other times, however, they would seem to go out of their way to confuse and deceive. Worse yet, it’s been my view that conventional “money” supply data tends to deliver their most confounding signals at key marketplace and Credit system junctures (i.e. major shifts in market perceptions and attendant financial flows).

The 2003 experience provides an illuminating case in point. The year proved pivotal for the upsurge in Credit Bubble Momentum. The Fed lowered rates to 1% in June, just a few weeks subsequent to Fed governor Bernanke delivering one of his seminal “reflationary” dissertations, “Some Thoughts on Monetary Policy in Japan.” M3 expansion had been slowing markedly. For the year, broad ‘money’ growth had declined to a rate of only 3.6%, about half of 2002’s 6.6% expansion and a fraction of 2001’s 12.9%. M3 was actually little changed during the second-half of 2003 and even ended the year with a $60 billion contraction over a 4-month period. There was at the time a groundswell of Money Babble about the falloff in M3 and how this indicated a contraction of Credit. Readers likely recall all the deflation hoopla.

The M3 aggregate had deceived. The reality of the situation was that Household Mortgage Debt was expanding at double-digit rates during this period, as the Historic Mortgage Finance Bubble shifted fully into overdrive. Total (non-financial) Credit was growing briskly, in the neighborhood of 7%, with Financial Sector borrowings expanding by about 10%. Several components of the monetary aggregates were stagnating, although the much more significant development was the major issuance boom in GSE, MBS, and ABS debt instruments (“structured finance” broadly). Curiously, the data was all there to elucidate the burgeoning Credit and Asset Bubbles, although many analysts were steadfast in their fixation on the M’s (and deflation risk).