Friday, July 13, 2007

A never ending story (fg)

... is the discussion about the lovely monetary aggregate M3. Paul de Grauwe recently commented that the use of M3 as information variable for forecasting future inflation in goods markets may not be accurate for several reasons:
  • Banks changed their liability maturity structures by switching from fixed deposits to debt securities and transformed illiquid mortgages to asset-backed securities on the asset side.
  • The net effect is that banks borrow less short-term and invest less long-term. The term transformation and thus, the overall liquidity must have other origins:
  • Hedge Funds; they made on the carry on the yield curve by borrowing short and investing long without any finance restrictions.
  • Hedge Funds's money in the mean time does not enter goods markets but creates asset price inflation on the capital markets.
  • To conclude, M3 might not be a good indicator for goods inflation but for asset inflation and financial stability in an era of non-restricted financial innovations.

Dear ECB, if you want to use banking information, use just the most plausible variable, i.e. credit growth to private sector and communicate it like that!