Bonsaï de l'argent magique

• Monetarism is trying a comeback. It may not help much to deal with our current inflation predicament
• Japan is a case in point. Rather than the gyrations in money supply, it’s the emergence of actual inflation which is questioning the current policy stance just as an “outsider” is about to take the helm of the BOJ.

The quest for the “dovish pivot” has been halted for now by the dataflow and stern signals from policymakers. It’s a fragile truce between the market and central banks though, so strong is the nostalgia for the friendly monetary policy of the previous decade. Yet, times are definitely changing, and the arrival of an “outsider” at the Bank of Japan is another sign. With Kuroda, the “last dove standing” is leaving the global stage, even if we don’t expect action from the BOJ for months after Ueda takes office in April.

It’s probably unsurprising in these circumstances that monetarism is attempting a comeback. We explore the pros and cons of returning to the “Old Faith”. Claudio Borio, who has just produced a thought-provoking note on the information content of excess money growth, concludes that taking on board developments in money supply would have improved the accuracy of the forecasts of the current inflation shock.

Our contention though is that, as much as the wild money creation of the pandemic may well have played a role in the current high-inflation episode, focusing on the gyrations of M3 may not help us in gauging the chances of proper disinflation in 2023 and 2024. The pandemic phase was very specific, as money supply rose for largely exogenous reasons – an acceleration in QE. In our view, a permanent high inflation/high money growth configuration would require the endogenous engine of money creation – bank credit – to switch on, which is not happening – quite the opposite if one takes a look at the credit impulse in Europe. However, the pandemic was not only characterized by excess money growth, but also by a collapse in the velocity of money, as cash holdings remained idle. The fate of this accumulated cash will determine to a large extent how the economy – and inflation – lands in the coming two years. This gets us back to the very reasons why monetary policy frameworks focused on monetary aggregates were quietly shelved two decades ago: as appealing as they might be theoretically, their practical use is limited.