Higher inflation > slower real broad money growth

  • Nominal broad money growth is slowing but is still inflationary.
  • Higher inflation is eroding real broad money growth, implying weaker activity.
  • The macroeconomic outlook for 2022 is decidedly less pleasant.

The fact that current inflation may not turn out to be transient (whatever that means) after all, is beginning to penetrate even the world of central banking. The Bank of England is close to raising interest rates, the Reserve Bank of Australia has abandoned its yield target on some bonds and even the Federal Reserve is sounding as if inflation is, if not here to stay, at least around for more than a quick visit, and is beginning to taper its quantitative easing.

So far, so good. However, this concern is so far not translating into the one measure that would ensure that inflation really is transient – a return to positive real interest rates. There are many reasons why this is not happening, above all the (justified) concern that a sharp rise in interest rates could derail the post-pandemic recovery.

However, not doing anything is also a problem. Because for any given rate of nominal broad money growth, a higher rate of inflation obviously means slower real broad money growth. In turn, slower real broad money growth is a sign of eventually slower real output growth. Since nominal broad money growth has been slowing, this means that real broad money growth is being eroded even faster.

As yet, this monetary weakness is not excessive. In fact, to some extent, it is welcome. As my former colleague Simon Ward points out, “Monetarists have a straightforward response to the ongoing debate about whether global inflation is shifting to a permanently higher level: it won’t if global broad money growth reverts to its pre-covid norm.”

However, this is not yet happening. A quick look at nominal broad money growth in the most important economies (excluding Japan, where circumstances are different) shows that the numbers, while down from a year ago, are still rather higher than in the years immediately preceding the pandemic:

Economy                                                         Nominal broad money growth

                                      Year to September     Average 2021        Average 2020     Average 2015-2019

USA (Broad money)                   10.2                      11.5                             20.6                   4.6

Euro Area (M3)                           7.4                        9.3                               9.0                   4.7

China (M2)                                  8.3                        8.8                             10.3                 10.2

UK (M4x)                                    8.6                      10.7                             10.5                   4.4

What these numbers tell us is that nominal broad money growth in the advanced economies remains roughly about twice as fast as in the five years to 2019. More to the point, they are not the type of numbers that are consistent with inflation easing in the near future.

(In China, the situation is different. Here, broad money growth continues the weakening trajectory that has been in place for years. This implies that the secular shift in Chinese growth towards a more ‘normal’ rate for an economy in its stage of development, i.e., in the 3-5% real GDP growth range, continues.)

Meanwhile, however, real broad money growth – a leading indicator of real output growth – is being hit by higher inflation. True, it is (again, with the exception of China) still stronger than before the pandemic – but not by very much.

Economy                                                         Real broad money growth

                                      Year to September     Average 2021        Average 2020     Average 2015-2019

USA (Broad money)                    4.5                        7.3                             19.1                   3.0

Euro Area (M3)                           3.8                        6.7                               8.5                   3.9

China (M2)                                  7.6                        8.2                               7.8                   8.1

UK (M4x)                                    5.1                        7.3                             13.7                   4.7

What all this adds up to is the prospect of continued elevated inflation well into 2022, with central banks remaining behind the curve in terms of higher interest rates. This will further erode real broad money growth, implying weaker output growth. At the same time, bond markets are once again jittery, with yields picking up.

It would be easy to cry ‘Wolf!’ or, in this case, ‘Stagflation!’. That may be too pessimistic. But on current trends, the numbers certainly add up to a not very pleasant macroeconomic outlook for 2022.