The Right Measure of the Money Supply

How useful have monetary aggregates been in signaling the stance of monetary policy in real time? These four panel graphs show business-cycle components of various measures of money supply. In particular, the Federal Reserve’s official M1 and M2 measures are shown, together with their Divisia counterparts constructed by William Barnett and his associates at the Center for Financial Stability (CFS) in New York City.

Rather than simply adding up the values of funds held in various types of bank accounts, as the Federal Reserve’s measures do, the Divisia aggregates draw on methods that explicitly recognize, for instance, that a dollar held in a NOW account is more liquid—and can therefore be said to provide a larger flow of “monetary services”—than the same dollar held in a three-month CD. Quite helpfully, too, the CFS aggregates also adjust the Federal Reserve’s official measures to remove the distortionary statistical effects of computerized problems that most banks now use to invisibly “sweep” funds on deposit in customers’ checking accounts into savings accounts for the purpose of minimizing statutory reserves requirements.