ECB Very Worried As M3 Growth Is Risk To Price Stability

Monday, November 21, 2005

Rumors that this blog will be renamed "Crusade for the continuation of US M3 Data" are unfounded. But cultural differences remain as the most recent monthly bulletin of the ECB, published today, shows. It devotes several pages to the worrisome growth in this monetary aggregate in the Eurozone which implies higher inflation in the ECB's view.

M3 EU USA September 2005

GRAPH: While M3 growth in the USA is scary the even stronger monetary expansion in the Eurozone looks horrifying given the comparatively sluggish GDP growth rates there. M3 grew 23.1% in the USA but 28.7% in the Eurozone since the inception of the common currency in January 2002. Data: Fed St. Louis, OeNB
According to the ECB,
"the ongoing strong growth of money and credit in an environment of more than ample liquidity points to increasing upside risks to price stability over medium to longer-term horizons. Moreover, these developments imply a need to monitor asset price dynamics closely, given the potential for price misalignments to emerge...The data for recent months confirm the strengthening of M3 growth observed since the second half of 2004."
M3 accelerated to to 8.5% in September 2005, from 8.2% in August. The three-month average of the annual M3 growth rates increased to 8.2% in the period between July and September 2005, from 7.9% in the period between June and August.
The ECB goes on to say that
"the September data support the view that the stimulative impact of the prevailing low level of interest rates has continued to be the dominant factor driving monetary dynamics. On the components side, the most liquid assets within M3 contained in the narrow aggregate M1 contributed most to the current high level of M3 growth. On the counterparts side, monetary expansion has been driven by the further increase in the annual growth rate of MFI credit to the private sector.
Given the robust growth in M3 over the most recent quarters, liquidity in the euro area is more than ample. This implies increasing risks to price stability over the medium to longer term, especially if a significant part of this liquidity were to be transformed into transaction balances at a time when confidence and real economic activity are strengthening. In addition, strong monetary and credit growth in the context of ample liquidity implies a need to monitor asset price dynamics carefully, given the potential for price misalignments to emerge."
There is indeed a different culture regarding the importance of M3 data at least in the official view of this set of data. See also the post "Fed Wants To De-Emphasize M3 Data."
Fed Abandons Old School Concepts
The Federal Reserve is abandoning old school concepts with its intention not to publish M3 data anymore after March 2006. A Fed St. Louis research paper from August 1968, another point in history when a free-spending US president created huge imbalances that led in combination with a too accommodative monetary policy to the 1970s inflation, starts with the note that
"the monetary base recently has achieved prominence as a measure of monetary influence on the economy. Other aggregates often used are the money stock..."

This is of note as a lot of commentators believe the Fed cannot control M3.
The paper's summary notes that
"the monetary base can be controlled by the Federal Reserve System and is directly influenced by its actions, even though other economic variables are used as guides by monetary managers."
More research papers on money stock aggregates can be found at the research section of the Fed St. Louis whose FREDII data collection is a treasure chest by itself.
William Polley Points At Recent Divergence Of M2 and M3
William Polley, Assistant Professor of Economics at Western Illinois University discussed non-M2 components last week at his blog and had this chart.

M2 M3 1985-2005

GRAPH: M2 and M3 have begun to diverge recently. Chart courtesy of William J. Polley.
Polley said the small gap that appears to be opening up bears watching. Well, according to disturbing announcement of the Fed dicussed here, here and here as well as at countless other blogs and websites this watch will have to end on March 26, 2006. We will have to fly by night from then on.
Trichet Beats The Rate Hike Drum
ECB president Jean-Claude Trichet meanwhile on Monday reiterated his calls that the governing council is prepared to change the leading overnight rate. His comments were an exact repetition of his remarks made last Friday.
The ECB will hold its next interest rate meeting on December 1. Be prepared for a 25 basis pont hike to 2.25% with a corresponding move in the margina lending facility to 3.25%.


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