Posted by: Dirk | April 9, 2013

M2 developments in the euro area (2003-2011)

The big question in Europe: is the collapse of the economies of Greece, Spain and Ireland caused by a decline in the monetary aggregate M2, or is the economic decline causing M2 to fall? I would argue the latter, as lenders frantically try to pay off existing back and new borrowing is very low. Not everybody agrees with that. Here is Milton Friedman and Anna Schwartz, as explained by Wikipedia:

In their 1963 book A Monetary History of the United States, 1867-1960, Milton Friedman and Anna Schwartz laid out their case for a different explanation of the Great Depression. Essentially, the Great Depression, in their view, was caused by the fall of the money supply. Friedman and Schwartz write: “From the cyclical peak in August 1929 to a cyclical trough in March 1933, the stock of money fell by over a third.” The result was what Friedman calls the “Great Contraction” — a period of falling income, prices, and employment caused by the choking effects of a restricted money supply. Friedman and Schwartz argue that people wanted to hold more money than the Federal Reserve was supplying. As a result people hoarded money by consuming less. This caused a contraction in employment and production since prices were not flexible enough to immediately fall. The Fed’s failure was in not realizing what was happening and not taking corrective action.

I don’t think that’s correct. People did not want to hold money, they wanted to and did repay debt. Some of them could not, and had to default on their loan. This is what destroyed the monetary aggregate. You can’t force people to borrow money.

m2gdp

Source: World Bank, Money and quasi money growth (annual %)

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