The most robust national income determination model is the monetarist model. The course of the economy when measured in nominal terms is determined by the course taken by the money supply. Indeed, the positive relationship between the growth rate of the money supply and both nominal GDP and nominal aggregate demand growth is unambiguous and overwhelming.
So, just what is the measure of money that is most suited for taking the temperature of the economy and forecasting its course? Is a narrow metric, like the monetary base (M0), the best? Or, should we focus on broad money metrics, like M3 and M4? For national income determination, the more inclusive the metric, the better. Indeed, for the most complete and accurate picture, one should include all the important components of money supply, not just a few.
To obtain money supply data is simple enough. Just go to the Fed’s monetary data base and pick the broadest money supply measure, and you will be ready to go. Right? No, it’s not that simple. First, since the Fed stopped reporting the M3 money supply measure in March of 2006, one is left with M2 as the broadest measure reported by the Fed. And, M2 is not very broad.
The Fed’s money supply measures are limited to rather narrow metrics, and that’s a problem. To obtain superior, broader measures, one must go to The Center for Financial Stability (CFS) in New York, where I serve as a Special Counselor. The CFS was founded in 2009 by Lawrence “Larry†Goodman to, in part, improve on the measurement and reporting of money supply statistics. The CFS was fortunate in that William A. “Bill†Barnett, the world’s leading expert on Divisia monetary aggregates, agreed to develop and lead the CFS’s Advances in Monetary and Financial Measurement program. As a result, the CFS, under Bill’s watchful eye, produces a detailed monthly report “CFS Divisia Monetary Data for the United States.†That report contains a broad money measure M4. It includes five more components than M2: institutional money-market funds, long-term deposits, repurchase agreements, commercial paper, and T-bills. These components are important because they all serve, in varying degrees, as money. To exclude them from a measure of money would be to exclude a great deal.
So, the CFS money supply metrics contain important components that are excluded in the Fed’s M2. In this sense, the CFS data are superior. But, narrowness is only the start of the Fed’s data problems.
