Guess what indicator predicted the last recessions?

and guess which indicator the Federal Reserve has decided not to publish anymore?

On March 23, 2006, the Board of Governors of the Federal Reserve System will cease publication of the M3 monetary aggregate.

As the Economist reminds us:

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.

Those experiences surely suggest that central banks should keep a close eye on the growth in money alongside their immediate inflation goals.

From another article:

Money still makes the world go around. For some policymakers, anyway

it would be foolish to conclude that money does not matter. Throughout history, rapid money growth has almost always been followed by rising inflation or asset-price bubbles. This is why Mr Issing, virtually alone among central bankers, has continued to fly the monetarist flag.

The ECB’s monetary-policy strategy has two pillars: an economic pillar, which uses a wide range of indicators to gauge short-term inflation risks, and a monetary pillar as a check on medium- to long-run risks. The monetary pillar has attracted much criticism from outside the ECB; it is often dismissed as redundant, if not confusing. It was originally intended to guard against medium-term inflation risks. More recently, Mr Issing has justified the pillar as a defence against asset bubbles, which are always accompanied by monetary excess.

(…)

Unlike some central bankers, Mr Issing loves to be challenged, so he invited Don Kohn, a governor of the Fed, to tackle the ECB view that a central bank should sometimes “lean against the wind” to prevent an asset bubble inflating, by tightening policy by more than inflation alone would require. Mr Kohn argued the usual Fed line: because of huge uncertainties, it is too risky to respond to bubbles and therefore it is safer to “mop up” by easing policy after a bubble bursts. He tried to present the Fed’s approach to asset prices as the neutral one, ie, less activist than the ECB’s. But that is misleading. There is no such thing as “doing nothing”. Under the Fed’s approach, unfettered liquidity sustains a bubble.

This link between money and asset prices is why the ECB’S twin-pillar framework may be one of the best ways for central banks to deal with asset prices. A growing body of academic evidence, most notably from economists at the Bank for International Settlements, suggests that monetary aggregates do contain useful information. Rapid growth in the money supply can often signal the build-up of unsustainable financial imbalances, as well as incipient inflation.

To simplify:

– the Europeans follow money growth closely, and have been accused of being needlessly restrictive in their monetary policy, and to worry too much about non-existent threats (inflation) – and thus of strangling growth;

– the Fed has had, for most of the Greenspan years, a policy of easy money, and even easier money in times of crisis (most crises having caused, of course, by imbalances generated by the presence of too much of the easy money they provided in the first place). Their justification has been that it is impossible to determine asset bubbles, and thus it is better to deal with the aftermath – thus the policy of debt, debt, more debt to keep consumers spending

– the Germans say explicitly that M3 is a good medium term indicator of imbalances and bubbles, and the Bundesbank then, and the European Central Bank today, uses it as an explict policy tool against bubbles;

– today, the M3 shows clear signs of froth again in the USA (in fact, it never stopped since the mid-90s):

(Note that the Fed rate was stuck at 1% between 2002 and 2004, an unprecedentedly low);

– And, hey presto, let’s hide the relevant information.

Yes, let’s hide the most obvious sign that there is indeed a monetary bubble (i.e. something that can be blamed squarely, unambiguously at Greenspan’s feet), so that people do not worry unduly, and the cheerleaders in brokerage houses and the business press can keep the happy refrain of growth and “borrow, buy, borrow, buy, borrow, buy”.

from the Economist again

So, in scrapping M3, the Fed is looking like the odd man out.

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. Central banks cannot use the money-supply numbers as a way to set monetary policy on auto pilot: but they would be foolish to ignore the hazard warning lights.

Unplug the hazard warning lights. Sounds par for the course for this administration.