Analysing the information content of money

A new research paper from the Bank of England examines what the quantity of money in the economy tells us about future inflation and economic activity, a question that has divided economists since the relationship between money supply and inflation appeared to break down in the 2000s.

The paper, published as a staff working paper, uses new statistical techniques to extract the information content of money from the noise that surrounds it. Its central finding is that money does still contain useful information about the future path of the economy, but that the relationship is more complex and conditional than the simple monetarist models of the past assumed.

The authors find that broad money growth remains a useful predictor of inflation over medium-term horizons, particularly when the money data is combined with information from credit markets and asset prices. The predictive power of money is strongest when inflation is high and variable, and weakest when inflation is low and stable — a finding that helps to explain why the relationship appeared to break down during the low-inflation period of the 2000s and 2010s.

The research has practical implications for monetary policy. The Bank of England, like most central banks, uses a range of models and indicators to inform its decisions, and the paper suggests that money should remain part of that toolkit, particularly in the current environment of elevated inflation and economic uncertainty.

The paper is part of a broader programme of research at the Bank into the lessons of the recent inflationary episode, which has prompted a fundamental reassessment of the frameworks that central banks use to understand and forecast the economy.