Sunday, September 21, 2008

Just How Strong?

Evidence I've observed over the years leads me to the conclusion that a change in the level of the money supply leads the stock market, the economy and the overall price level, but with different lag times.

Money and Stock Prices

An increase in the money supply results in an almost immediate increase in stock prices and a decrease results in an almost immediate decline, "immediate" being a matter of days to a week or so.

Money and Economic Activity

An increase in the money supply causes an increase in overall economic activity rather quickly, but it generally shows up in the relevant statistics, such as retail sales, durable goods orders, employment numbers and finally GDP, with a lag that is very close to six months, plus or minus a month, rarely two months.

Money and the Inflation Rate

Inflation lags money by years. A strong increase in the money supply might only begin to show in inflation numbers after two years or longer and the effect of the increased money supply will persist long after the money supply has been brought under control, again for two years or longer.

But what is money?

That's the rub. In the next post I'll explain why only two measures have worked over the years and the reasons neither can be trusted to be consistent. That does not mean, however, that the effect isn't present; only that we lack consistent measures from time to time. All of this is covered in the monograph I linked to yesterday, incidentally, and a great deal more.

Next Post: Currency is a Lagging Indicator

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