Wednesday, March 17, 2010

Did A M3 Decline Blindside The Fed And Cause The Economic Crisis

wondering how M3 has behaved compared to M2 or M1 during this crisis. Based on [Gary] Gorton's discussion it would seem that M3 would better reveal the impact of the crisis.
From "The Correct Money Supply Measure for This Crisis" by David Beckworth on the Macro and Other Market Musings blog.

FYI: Money Supply Definitions from Wikipedia:
  • M3: M2 + all other CDs (large time deposits, institutional money market mutual fund balances), deposits of eurodollars and repurchase agreements.
  • M2: M1 + most savings accounts, money market accounts, retail money market mutual funds,and small denomination time deposits (certificates of deposit of under $100,000).
  • M1: The total of all physical currency part of bank reserves + the amount in demand accounts ("checking" or "current" accounts).
Gary Gorton's paper mentioned by Beckworth with thanks to Mark Thoma is well worth a read. It is an excellent explanation of the mechanism that turned a housing crisis into a banking crisis and an economic recession. The upshot is that the Fed was not watching the repo market as it collapsed and failed to take timely corrective action to replenish this loss of liquidity.

[Addendum: regulation2point0 blog mentioned Gorton's paper on March 6, 11 days before Thoma.]

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