Canada and US monetary policy - a Market Monetarist perspective

Market Monetarists maintain monetary policy should target nominal spending growth, not inflation.  They argue that had the Federal Reserve kept nominal spending at its pre-recession trend, the drop in real output would have been much less severe during the Great Recession.

Interest rates are used by most economists as a monetary policy indicator.  Market Monetarist argue that nominal GDP growth is a better monetary policy indicator. Nominal GDP growth above trend implies easy monetary policy, while below trend growth implies tight monetary policy.

Given the Market Monetarist perspective, what can we stay about the relative monetary stance between Canada and the United Stated?  Using data from the Bureau of Economic Analysis and Statistics Canada, the chart below compares NGDP from 2000 to the end of 2011 for both Canada and the US.  From 2000 to the end of 2006, NGDP growth was similar, averaging 5% annually, which is shown as the trend line.

 



After Q4-2006, NGDP growth in Canada began to grow above trend, while in the United States, growth continued at trend to about Q2-2008, at which point it began to fall below trend.  In  Q4-2008, Canada NGDP growth was almost 3% above trend, while US NGDP growth was about an equal amount below trend. By Q1-2009, both Canada and United Stated were below trend 3.2% and 6.8% respectively - we were in the Great Recession.

NGDP both in Canada and the United States bottomed in Q2-2009. How has NGDP growth and the relative monetary policy stance compared since?

From the graph below, NGDP growth has been much stronger in Canada since Q2-2009, growing at 6.1% annually.  This is above the 2000-2006 trend rate, implying a relatively easy monetary policy stance.  At this growth rate, Canada would regain its pre-recession trend level in 2018.  However, if the objective is to keep nominal spending at 5%, the current monetary stance may be too easy. For the United Stated, NGDP growth continues to be below trend since the bottom of the recession, implying monetary policy is too tight.



If the current trends in NGDP continue, implying a tighter monetary policy in the United States, the implications for Canada would be a higher relative inflation rate, and as well, a depreciating Canada dollar. 

Why I called this blog Saving and Investment

I called this blog Savings and Investment because the basic national income accounting entity that equates savings with investment symbolizes, in my mind, the difficulty connecting finance with economics. With the national income account and some basic algebra, the savings equals investment equality can be easily derived:

Y = C + G + I + NX  (output = consumption + government + investment + net exports)
Savings =  Y - C - G (savings = output - consumption - government
Savings = I + NX  (savings = investment + net exports)
Savings = Investment (for a closed economy or the world as a whole)

Does the savings equals investment equality imply that when an individual saves part of their income, in the form of a bank deposit, investment increases by the same amount?  The answer is no.  Does the answer change if your saving is used to purchase equity in a company? Not necessarily. Do banks refuse to lend money to consumers because of a lack of savings?  Again, no. These answers are not intuitive given that savings equals investment.

With my graduate degree in economics and the CFA designation, I have not, to my satisfaction, been able to bring the pieces of my knowledge together to form a coherent understanding of how finance and economics interacts.  For example, some economists maintain monetary policy in the United States in the early to mid 2000s was too loose, causing asset price bubbles, ultimately leading to the financial crisis.  Other economist claim monetary policy was appropriate.  Who's right?  I want to know!

Macro economists have traditionally, following the lead of Paul Samuelson, concluded that finance is merely a "veil" between savers and borrowers, having no real impact on the economy.  The recent financial crisis clearly demonstrates finance is more than a veil, and matters to the real economy.

I intend to explore these and related issues in this blog.