research

Wonk alert. The ECB has just published a book robustly defending monetary analysis and arguing that, taking a medium time horizon, monetary indicators – whose usefulness has been doubted in recent years – were never really wrong.

“One does not need to rely on exceptional or aberrant behaviour in the financial sector to explain developments in money and credit over the past 18 months,” says an accompanying statement. “Once the prevailing level of economic activity is taken into account, it appears that money and credit have actually behaved in line with pre-crisis regularities.”

Edited by two ECB big cheeses Lucas Papademos and Jürgen Stark, the book is the fruit of three years’ analysis. It comes in two parts: the first, explaining the theory and practice of monetary analysis; the second, containing research into how that analysis can be improved. Don’t expect any sudden changes in the ECB’s monetary analysis, though: the research since 2007 that has gone into this book has already been incorporated into the central bank’s toolkit.

So why publish the book? 

Just how much additional growth does a stimulus package buy you? (1.65 x stimulus) – 2.1, apparently, where stimulus is a percentage of GDP. (Example – a stimulus measuring 3 per cent of GDP should produce growth that is 2.85 per cent above expectations.)

Policymakers would hope that spending relatively more stimulus would bear some fruit. And so it appears from the Economic Report of the President.

Chart found on p.105. Please note the power of stimulus to explain above-forecast growth is quite low (R² = 0.31), and the data is taken at a very specific snapshot – November forecasts and Q2 results. Results for Q3 results were not statistically significant.

There is a twist, however. Middle-of-the-road stimulus spenders did not receive expected levels of benefit – and they include the US, UK and Canada, well below trendline in the scatterplot. It seems fortune favours the brave.

And country-by-country figures: 

Both output volatility and depth of recession experienced in the OECD were negatively correlated to trade openness and exposure to terms-of-trade shocks. They also exhibited strong negative correlations with inflation volatility. The latter suggests that, to the extent that monetary policy succeeded in stabilising inflation, it also played a key role in explaining differences in output volatility – both between countries, and over time.