Inflation is Still a Monetary Phenomenon
A quarter of a century ago, control of money was seen as both necessary and sufficient to curb inflation — so most central banks set monetary targets. Financial deregulation and innovation made the money supply harder to interpret. As the link between money and prices seemingly broke down, central banks scrapped money targets and instead focused on inflation directly.
America’s Federal Reserve has announced that it will stop publishing M3, its broadest measure of money. The Fed claims that M3 does not convey any extra information about the economy that is not already embodied in the narrower M2 measure. It is true that the two Ms move in step for much of the time, but there have been big divergences. Over the past year, for example, M3 has grown nearly twice as fast as M2.
As Milton Friedman famously said, “Inflation is always and everywhere a monetary phenomenon.” Monetary aggregates are a fickle guide to the economy over the next year, but over longer periods the link between money and prices still holds. Many big mistakes in economic history were made when policymakers ignored monetary signals: the Great Depression in the 1930s, the great inflation of the 1970s, and the financial bubbles in Japan in the late 1980s and East Asia in the late 1990s.
Research by the Bank for International Settlements has confirmed that monetary aggregates do still contain useful information. In particular, rapid growth in money and credit as well as asset prices usually signals the build-up of economic and financial imbalances, which often cause financial stress later on.
“Running on M3,” The Economist