The analysis will be split into four parts; the first, an analysis on the relationship between nominal spending growth and broad money growth; second, between housing price inflation and the money gap; third, between equity price inflation and the money gap; and fourth, an analysis of recent and sustained trends in money gap decline and how it is manifesting in other trends.
The diagram above shows quarterly annualized trends in nominal spending growth and the money gap over the post-crisis period. There are roughly three periods of note: the Q1 2011 – Q3 2013 period; the Q3 2013 – Q4 2015; and the Q4 2015 – Q2 2019.
Period 1: Q1 2011 – Q3 2013 – Over the Q1 2011 – Q3 2013 period, we see both a sharp contraction followed by a sustained recovery and increase in the money gap preceding a similar trend in nominal spending growth, with the money gap dropping from -2.14% in Q3 2011 to -3.5% in Q4 2011, before rising to a peak of 0.3% in Q4 2012.[1] Shortly after the drop in the money gap, nominal spending growth dropped from 3.3% in Q4 2011 to 1.5% Q1 2012, before recovering to a peak of 4.5% in Q3 2012. Both the money gap and the nominal spending growth stabilised around their respective peaks for the rest of the period. This appears to be a period in which both the status of the money gap as a leading indicator, as well as the evident positive and proportional relationship between the two trends, indicate a clear effect of broad money growth on nominal spending growth.
Period 2: Q3 2013 – Q4 2015 – The relationship is more ambiguous over the Q3 2013 – Q4 2015 period. There occurred an upward trend in nominal spending growth from 3.6% in Q3 2013 to 5.6% in Q2 2014, followed by a declining trend with a trough of 2.3% in Q3 2015. However throughout the whole of the period, the money gap remained at very stable rates of around -1%, which in fact falls within the 0 ± 1% range of price-stability and trend output growth compatible money gap values. If volatility in monetary factors cannot explain the trend in nominal spending growth over the period, it is left to an analysis of short-term and real factors.
Three factors seem noteworthy; annualised quarterly gross capital formation growth increased rapidly from -2.6% in Q1 2013 to a peak of 10.9% in Q1 2014 (indicating a year of rapid increases in domestic investment), before going on a downhill trend for the rest of the period; by Q4 2014, it had decreased to 4.9%. In addition, growth in annual government consumption expenditure increased from 0.45% in 2013 to a peak of 3.03% in 2014, before declining to 1.1% in 2015. Finally, and by far most extremely, annual growth in inventories peaked at 395% in 2013, before declining to 24.73% in 2014 and -45% in 2015; a huge increase directly preceding by roughly a year the peak in nominal spending growth.[3]
Period 3: Q4 2015 – Q2 2019 – Over the Q4 2015 – Q2 2019 period, the relationship once again becomes clear. Preceding a rise in nominal spending growth from 3% in Q2 2016 to 4.9% in Q4 2016 was a rise in the money gap from -1.1% in Q4 2015 to 2.7% in Q3 2016; however the sharp rise in the money gap proved to be a one-off, and by the time it returned to roughly similar values of 0 to -1% in Q1 2018, nominal spending growth had likewise returned to around 3%.[2] Concurrent with the exacerbating declining trend in the money gap starting from Q3 2016 however, nominal spending growth has been on a declining trend, albeit to a lesser extent than the money gap, from Q4 2016 onward.
Housing Prices and the Money Gap – As one might note from the graph above, the recent decline in the money gap has manifested very clearly in changes in housing prices; over the Q3 2017 – Q2 2019 period, housing price growth has been on a downward trend from 4.69% to 1.35%, analogous to the money gap decrease from -0.3% to -2.9% over the same period.
Share Prices and the Money Gap – The effects of the money gap contraction are even more severe in share price inflation; from Q2 2017 to Q2 2019 the change in total sare prices fell from a peak of 18.97% to -2.41%
Prospects for Price and Output Growth in 2020 – It is clear from this analysis that we must account for the effects of money growth on nominal spending growth, output growth, and changes in asset prices. The risk is clearly seen that if this exacerbating negative trend in the money gap is sustained, further falls in asset prices will persist and eventually spill over into nominal spending growth,[4] and will eventually manifest as deflation in prices and below-trend output growth of goods and services. The current rate of money growth does not appear to be sufficient to support an on trend rate of growth of the economy.
[1] The rise is concurrent with the announcement of increases in the ceiling of asset purchases financed by central bank reserves of £75b in Q3 2011, £50b in Q1 2012, and £50b in Q2 2012, bringing the total ceiling to £375b maintained for the rest of the period.
[2] This is likely explained by the Bank of England’s injection of £3.1b in the banking system as a ‘precautionary measure’ to assuage any fears following the referendum.
[3] As businesses stock up under times of uncertainty, this is likely explained by David Cameron’s 2013 announcement that should the Conservatives win the election, a referendum would be passed concerning the UK’s membership to the EU.
[4] For more information concerning the asset circulation, the income-expenditure circulation, and the leakages between the two, see Tim Congdon’s A Critique of Two Keynesian Concepts, full research paper available here: https://mv-pt.org/research-papers/