The United Kingdom’s money-supply economists, who gained prominence during the pandemic by accurately predicting high inflation rates, are raising concerns again. They argue that collapsing money supply growth in the UK, Eurozone, and US could indicate an impending recession and deflation. Central banks might have increased interest rates excessively, and if these economists are proven correct once more, a major overhaul of central bank officials may be necessary.
The Monetarist Viewpoint
Simon Ward, economic adviser to Janus Henderson, and Tim Congdon, the UK’s foremost expert on the subject, have long held that growth and inflation are determined by the quantity of money in circulation and its velocity. This perspective contrasts with the mainstream consensus that attributes inflation to supply shocks and energy prices. However, current data on money supply and its velocity suggest an imminent economic downturn.
Ward and Congdon believe that the massive quantitative easing (QE) programs and aggressive interest rate cuts implemented by central banks during the pandemic led to double-digit money supply growth in the US and Europe, followed by inflation rates that exceeded targets and approached 10%.
Now, money supply growth is plummeting. Measurements like M3 broad money and M1 narrow money in the Eurozone and real M4 growth in the UK all signal potential recession, disinflation, and deflation.
The Need for a Shift in Monetary Policy
Vincenzo Inguscio, a London-based volatility strategist at Nomura, warns that the recent contraction in the US’s M2 money measurement suggests the Federal Reserve may have overcorrected by tightening monetary policy too much.
To combat the highest inflation in four decades, central banks have raised rates at the fastest pace since the late 1980s and are reducing QE. However, Congdon and Ward argue that central banks should have stopped hiking rates earlier and should consider reversing course on “quantitative tightening.” Restoring positive money growth is essential, according to Ward.
Falling money supply could be a precursor to deflation, or it may simply reflect the recent banking crisis and financial market instability caused by the aggressive rate-hiking cycle. RBC Capital Markets suggests that money is shifting within the Eurozone’s banking system, but loan and money creation are dramatically slowing.
Meanwhile, in the US, deposits are leaving the banking system, causing liquidity pressures on banks. The ongoing banking turmoil could exacerbate the money supply crunch as lenders become risk-averse and restrict credit.
A Call for Change in Central Bank Frameworks
Congdon proposes that central bank frameworks should be adjusted to incorporate a reference to broad money. He believes that the Federal Reserve, European Central Bank, and the Bank of England are responsible for the current inflation rates plaguing their economies and will be accountable for the recessions predicted to hit these regions by mid-2023.
Bank of England officials, such as Silvana Tenreyro, a monetary policy committee member, argue that it is incorrect to blame QE for soaring inflation rates. In a speech titled “What did the monetarists ever do for us?”, BOE Chief Economist Huw Pill argued that modern economics has adopted some monetarist ideas but rejected its views on policy transmission, which have been seen as discredited since the mid-1980s.
Despite the pushback from central bank officials, the warnings from money-supply economists like Congdon and Ward should not be taken lightly.