Monetary data shows some very steep decelerations in money supply growth for many countries

Their conclusion from this is that economies are likely to ground to a halt, or worse, and probably very soon. But is there any truth in this?

Unsurprisingly, many of those that argue the rapid fall in money supply growth rates implies significant economic weakness do so because policy rates have soared and central banks have ended their quantitative easing (QE) programs. Again, many of the same commentators argue that it was prior rate cuts and quantitative easing that led to the rapid monetary growth that fed the inflation that we are all seeing today. On the surface, this may seem a reasonable argument but, as often the case, first sight can be misleading.

Bank of England member Tenreyro said in her recent speech, quantitative easing does not expand the money supply and nor does quantitative tightening (QT) contract it. She argues that QE and QT should be seen as an asset swap. For instance, commercial banks lose one asset, which are the bonds sold to central banks as part of QE, but gain another, which are the interest-bearing reserves that central banks issue in order to finance the purchase of bonds. But while this is correct in a mechanistic sense, the issue is a little more complicated still.

Tenreyro’s argument, which is the same used by many other central bankers, is that QE works only through producing lower interest rates (bond yields) than would have been the case in the absence of such a policy; it does not lift monetary growth.

Mr. Steve Barrow, Head of Standard Bank G10 Strategy doesn’t doubt that QE does lower rates but, to the extent that lower rates stimulate economic activity and the demand for money, it can lead to higher monetary growth if the money supply is driven up by this rise in demand. Put in a slightly different way, QE encourages the financial system and the economy more widely to make more use of money; to spend it rather than save it, for instance. Of course, this might not happen, and many would argue that QE failed in this sense as banks have tended to keep much larger reserves with central banks. Nonetheless, QE can expand money supply if it encourages stronger activity and money demand and, in the same way QT can do the opposite.

However, just to make things a bit more complicated, Mr. Steve Barrow suspects that QE is not the same as QT when it comes to its monetary consequences. This is because QE tends to occur when policy rates are close to zero as central banks try to eke out lower long-term rates. It also often comes alongside forward guidance about the longevity of low policy rates and, very often, the longevity of bond purchases. So there tends to be a much bigger signalling effect when QE is undertaken relative to QT when there’s no such forward guidance about the longevity of high policy rates, for instance.

In other words, QE should be worth more than QT when it comes to the impact on interest rates and, all else equal, we would expect a bigger response in money demand from QE and hence money supply. All this rather leads us to the conclusion that there do seem to be reasons to be concerned that the rapid slowdown in monetary growth does herald a stalling in economies. But if this does turn out to be the case will central banks pause QT?

In Mr. Steve Barrow’s view, QT will only be adjusted if financial stress increases. We saw this in the UK last September/October when the BoE pushed back the start of QT and temporarily went back to QE. From here on, central banks are likely to adjust their balance sheets in times of stress and not use them as a more active tool of monetary management as we saw when policy rates were stuck at zero. Instead, if stalling money supply does herald significant economic slowdown it is more likely that policy rates will be adjusted and QT left on auto-pilot.