Why is M2 Still a Component of ECRI’s WLI?

M2, a measure of money supply, has traditionally been recognized as a particularly reliable indicator of economic conditions. Recently, however, with the introduction of new financial instruments and the increasing importance of credit markets, the value of M2 as a leading indicator has been questioned.

For example, Stock and Watson (1989) decided against including M2 in their index of leading indicators. In 1993, the Federal Reserve Chairman, Alan Greenspan, informed Congress that M2 had been “downgraded as a reliable indicator of financial conditions in the economy” and that “the historical relationships between money and income had broken down”. Anderson and Vahid, Macroeconomic Dynamics September 2001

In an attempt to understand ECR’s Weekly Leading Indicator (WLI), we have by means of a statistical analysis come to the conclusion that ECRI still uses M2 as a component in the WLI. Whereas leading economists, more than ten years ago, had already downgraded and excluded M2 as a leading indicator from their models.

The full study is published as a research article.

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