The Money Supply Measures

For anyone that studies the money supply, it can be quite confusing.  There are different measures of the money supply and you can read or listen to three different people come to completely different conclusions, based on different measures of the money supply.

Robert Murphy has written a piece that gives a good summary of what makes up some of these different money supply measurements.  It certainly can be confusing on what measurements you use and what you should use them for.

First, a big reason for looking at the money supply in the first place is because we want to predict price inflation.  The only problem is, there are so many variables.  There are different measures of the money supply, but there are other factors too.  There are excess reserves held by banks, there are loans, and there is the velocity of money or the speed at which money is changing hands.  These all have an effect on prices.  In addition, an inflation in the money supply may show up in asset prices like stocks or commodities while not showing up in consumer prices.

With that said, we still want to have a useful measure of the money supply.  My personal favorite is the monetary base.  The reason I focus on this measure is because it is the measure that is most directly controlled by the Fed.  For example, with QE2, you will see the Fed's buying of bonds show up in the monetary base.  The Fed can buy or sell assets and change the monetary base.

Now that banks are piling up excess reserves, we have to pay attention to this too.  But overall, the monetary base tells us what the Fed is doing.  It can't tell us with any certainty what is going to happen with price inflation or the stock market or commodities, but neither can any of the other measurements.  At least the monetary base can accurately tell us what the Fed is doing and can at least provide us with that little piece of the puzzle.  Right now, it is telling us to watch out for rough waters ahead and to buy gold.