Money Supply & Financial Measures Compound Annual Growth Rates


The growth of various measures of money supply have frequently been used to indicate future expected inflationary trends in the economy.  Similarly, it has been suspected that easy money has been good for growth in stock markets.  The Federal Reserve (Fed) sets targets for growth in money (previously M1-M3, now primarily M2) and both preliminary weekly and monthly results are studied by analysts and forecasters.

Weekly or monthly growth rates may vary, but the Fed tries to adjust as needed, and the annual rates are usually close to targets. Historically, the stock market indices are not targeted, but Former Federal Reserve Chairman Greenspan has indicated that the Fed watches the stock market for excessive growth and significant “wealth effects.”  More recently, it seems the Fed is considering the drastic declines that have occurred in the stock market. Hence, changes in growth rates indices should be of some interest to the Fed and to average investors who observe how their wealth and retirement funds are growing or decreasing.

Since the US economy typically grows year-to-year, most economic variables have a natural upward trend. Thus, they typically have positive growth rates. Some economists argue that because most growth rates are positive, the rates of change in growth rates are more meaningful when analyzing economic trends and relationships among economic variables. Due to the UAE Dhs peg to the USA dollar, it is expected that monetary policy of the USA may affect the monetary aggregates of the UAE 

The objectives of this assignment are to analyze the historical relationships between various monetary aggregates and related economic variables. Included are measures for consumer credit (Cons Credit), inflation measured by the Consumer Price Index (CPI), the Federal Funds rate, GDP, the broad stock market (S&P 500), and M1and M2 data are included for years from 2002-2018, which means 16 years of changes will exist.  The data for monetary aggregates (M1 and M2) are in $Billions for the US data available at the Federal Reserve website. and on Research Stouisfedorg.

Compute the rate of change in: M1, M2, S&P 500, CPI and Cons Credit. That is, compute the year-to-year changes in the growth rates of these variables.

  1. Calculate the year-to-year changes in the Federal funds rate.
  2. Compute the average growth rate or average year-to-year change for each of the variables from your calculations in (1) and (2).
  3. Create a correlation matrix using the results from (1) and (2). (In Excel, go to Tools>Data Analysis>Correlation.)
  4. Using the correlation matrix, discuss the relationships between:
    1. The rates of change in M1, M2, and the yearly changes in inflation.
    1. The year-to-year changes in the Fed Funds rate and CPI.
    1. Consumer credit to the rate of change in M2 and the growth rate of GDP.
    1. The rate of change in M2 and the growth rate of the S&P 500 index.
  5. Graph the growth rates of the variables and discuss noticeable time trends.
  6. Apply OLS regression with money supply measures and inflation. (use money supply measures as explanatory variables) Comment on the relationship that you find. Is it as expected?

Comments may be included on the spreadsheet or on a separate sheet.

Example of discussion between economic variables:

The Fed Funds rate and Inflation: Suppose that the correlation between these two variables were negative. As we have learned this semester, the monetary policy of the Federal Reserve has shifted from a goal of full employment to a goal of low price inflation combined with sustainable economic growth. Thus, as inflation increases, threatening economic growth, the Fed raises the Fed Funds rate to curtail and prevent higher inflation. So, it should be expected that as the Fed Funds rate is raised, economic growth will slow and inflation will decrease.

Money Supply & Financial Measures Compound Annual Growth Rates

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