Money Supply Grows Faster Than Real Gdp

The 'M2 Money Supply', also referred to as 'M2 Money Stock', is a measure for the amount of currency in circulation. M2 includes M1 (physical cash and checkable deposits) as well as 'less liquid money', such as saving bank accounts. The chart above plots the yearly M2 Growth Rate and the Inflation Rate, which is defined as the yearly change in the Consumer Price Index (CPI). When inflation is high, prices for goods and services rise and thus the purchasing power per unit of currency decreases.
Historically, M2 has grown along with the economy (see in the chart below). However, it has also grown along with Federal Debt to GDP during wars and recessions. In most recent history, M2 growth surpassed 10 percent in the crisis of 2001 and 2009, during which an expansionary monetary policy was deployed by the central bank, including large scale asset purchases.
According to Bannister and Forward (2002, page 28), Money supply growth and inflation are inexorably linked.

Money Supply Growing At A Faster Rate Than Real Gdp May

Data Sources

Money supply times the velocity of money equals the price level times real output. The quantity theory of money predicts that, in the long run, inflation results. When the Federal Reserve Board of Governors increases the money supply faster than usual, interest rates rise. When the Federal Reserve Board of Governors increases the money supply faster than usual, interest rates don’t change in the short run, but we will get substantial inflation. Based on the quantity theory of money, if velocity is constant, inflation is likely to occur when: A. The money supply grows at a slower rate than real GDP. The money supply grows at the same rate as real GDP. The money supply and inflation are unrelated. The money supply grows at a faster rate than real GDP. An Inconvenient Truth For The Fed. Per the inflation identity, the rate of inflation or deflation (%P) is equal to the rate of money growth (%M), plus the change in velocity (%V), less the rate of.

  • M2 Money Stock
    • Federal Reserve Bank of St. Louis: M2 Money Stock since 1959
    • United States Census Bureau: Historical Statistics of the United States, Colonial Times to 1970 (M2 Money Stock until 1959, Chapter X, pages 992-993). Following Bannister and Forward (page 28), M2 prior to 1959 is calculated by adding 'Currency held by the public' + 'Deposits adjusted, commercial banks' + 'Bank vault cash' + 'Monetary gold stock' + 'Deposits at nonbank thrift institutions'
  • Inflation
    • Federal Reserve Bank of St. Louis: CPI since 1913
    • Robert Shiller Online Data: CPI from 1871 until 1913
  • US Gross Domestic Product
    • Federal Reserve Bank of St. Louis: US Gross Domestic Product
    • Congressional Budget Office: Historical Gross Domestic Product

Further Information

  • Investopedia: What is M2?
  • Investopedia: What is Inflation?

The Japanese economy has been on a recovery track since mid-2012, due in part to Abenomics. Although the economy has slowed recently, it is expected to turn upward again, thanks to additional fiscal and economic measures, high stock prices coupled with the weak yen, and the low price of oil.

A policy that particularly merits attention is the quantitative easing by the Bank of Japan with its goal of purchasing 80 trillion yen of Japanese government bonds annually as it strives to achieve a 2% price stability target. Long-term interest rates are at its lowest level ever, between 0.2% and 0.3%. Moreover, because of trends such as the growing gap between Japan and U.S. interest rates, Japan is seeing high stock prices coupled with the weak yen. These can be expected to further improve business/consumer confidence and inflation expectations from both corporations and households.

A look at the Japanese nominal gross domestic product (GDP) and the money supply (M2 base) in recent years shows that whereas the money supply continued to increase from the mid-1990s until recently, nominal GDP has been flat. Such a long-term deviation between nominal GDP and the money supply seems highly irregular as economic growth typically indicates additional demand for financing. If the money supply increases sharply, financial assets and real estate prices rise while exchange rates fluctuate, and such trends are expected to have an impact on economic growth as well. In the major economies of Europe and North America, nominal GDP and money supply grow together.

So why are nominal GDP and the money supply diverging so conspicuously from each other solely in Japan? One reason has to do with where the money is diverted to once the supply has increased. The most important part of the increase in the money supply since 1995 has gone toward purchasing the expanded amount of Japanese government bonds. In other words, the money went into public works, which have a lower economic multiplier effect than private investment.

The biggest reason of all has to do with business behavior. In the last 20 years since the collapse of the real estate bubble, businesses increasingly have shown a tendency to contract and households have not been able to increase their consumption. Given this background, domestic demand has been sluggish and deflation has kept nominal GDP in check. The impact of deflation has been particularly significant. Assuming that Japan's rate of price increases (GDP deflator) had been the same as that of the United States, that, combined with Japan's nominal GDP, would lead to a big increase consistent with growth in the money supply (Fig. 1).

Money Supply Growing At A Faster Rate Than Real Gdp Means

Figure 1: Changes in Japan's Nominal GDP and Money Supply
(Note) 'Adjusted nominal GDP' refers to Japan's GDP deflator adjusted with that of the United States
(Source) Bank of Japan, Cabinet Office, Ministry of Internal Affairs and Communications, U.S. Bureau of Economic Analysis