In an earlier posting, I noted that the index of leading indicators went up in December. Well, here is the story why this is not necessarily good news. From the Wall Street Journal Real Economics blog:
On Monday, the Conference Board released its index of leading indicators showing a surprise 0.3% increase. However, all of the benefit came from the increase in the money supply, and economists are questioning whether it should be used in the index at all.
The leading indicators index incorporates the data from 10 economic releases that traditionally have peaked or bottomed ahead of the business cycle. Some economists use it as a way to predict the direction the economy will take. But over the last few years, one of the key components -- the real M2 money supply -- may have been distorting the index.
The money supply measure at one time had a tight correlation with measures of growth, with M2 leading changes in the economy. Harm Bandholz of Unicredit says that in the past people put money into accounts measured in M2 in anticipation of higher spending. M2 measures demand deposits, traveler's checks, savings deposits, currency, money market accounts and small-denomination time deposits.
However, in the last 20 years or so that correlation has changed. "People have other places to put money when times are flush now," said Bandholz. "If you want to hold liquid assets, you don't have to hold it in M2-type accounts."
The Journal piece has a wonderful graph showing how there is actually a negative correlation now between M2 and economy activity.
So rather than being good news, the December M2 measure is yet another negative sign,
As the Church Lady used to say, "never mind."
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