M4 money supply is defined as a measure of notes and coins in circulation (M0) + bank accounts. It is known as a ‘broad’ measure of money supply.
It includes private-sector retail bank and building society deposits + Private-sector wholesale bank and building society deposits and Certificate of Deposit. [link]
M4 Money Supply
M4 is a key statistic because it shows the underlying strength of economic activity. When the economy went into recession, we see a sharp fall in M4 growth from 15% a year to negative growth in mid 2008.
The negative M4 growth during 2011 and 2012 was a sign that economic activity was falling and unsurprisingly the economy went into a double dip recession.
The governor of the Bank of England, Mervyn King has said that M4 remains an important variable for influencing monetary policy. Negative M4 growth is a key factor in the justification for more quantitative easing, and recent attempts to bolster bank lending.
At the start of quantitative easing, M.King said:
“the unprecedented actions of the Monetary Policy Committee to inject £200bn directly into the economy…have averted a potentially disastrous monetary squeeze” Bank of England pdf)
To some extent, M4 is becoming as important as the headline inflation rate in determining monetary policy. CPI inflation has often been above target, but the Bank, with some justification, have argued this headline rate is a misleading guide to the output gap and inflationary pressures.
A resurgence in M4 will be a key factor in ending quantitative easing.
Though, the money supply growth figures also suggest that quantitative easing was limited in its ability to stimulate bank lending and get money to the real economy.
Money Supply M3 and M4
Different measures of M3, M4 show strong growth (over 10%) until 2009, where growth rates fall. In 2012, we see a fall in M4 lending, and M4 liabilities.
Inflation has been above target during this period of negative broad money supply growth.
Why can inflation be high and yet money supply growth negative?
- Inflation is still affected by cost push factors, higher imported prices, raw material prices, taxes.
- The fall in money supply reflects the depressed nature of the economy and fall in investment.
- In 2007, the household savings rate was 2.3%. In March 2012, this has increased to 7.7%.
- Consumer confidence shows little sign of recovery, and the banking sector was still very weak.
- The relationship between money supply and inflation has always been weak. Money supply can vary due to changes in way of managing bank accounts and money
Historical Broad Money supply growth
UK Broad money supply. Source: Bank of England
M0 notes and coins
This is a ‘narrow’ definition of money, it includes just notes and coins in circulation