|
Related Topics |
|
In today's blog we take a look at South Africa's M3 money supply and its correlation to South Africa's official inflation rate. M3 money supply can broadly be defined as the liquid cash in a country's economy (this includes easily accessible deposits, actual notes and coins etc). While looking at M3, we will also take a look at M1 which is actual notes and coins in circulation in South Africa and how that corresponds to both M3 and the official inflation rate.
|
How much cash is in circulation in SA's economy?
The line graph below shows the Rand value of notes and coins (M1) in circulation in South Africa. In January 2017 M1 money supply in South Africa stood at just over R1.6trillion. A staggering amount of money. Economic theory dictates the more notes and coins in circulation the higher the inflation rate will be as excess cash will be spent by consumers, retailers realise that consumers are spending more, and therefore push up prices more to earn fatter margins.
The next graphic will take a look at the year on year growth rates of M1, M3 and the official inflation rate (CPI). From there we will take a look at the average annual growth rates of each as well as the correlations between M1 and CPI and M3 and CPI. In order to determine whether the movements in M1 or M3 can be used to explain some of the movements in the CPI.
The line chart below shows the year on year percentage changes of M1, M3 and the CPI. As can be seen from this graphic, the growth rate of M1 far oustrips that of both M3 and the official inflation rate. And the year on year growth rates of all the series do look extremely volatile. Question is do they follow similar patterns or trends over time? Hard to tell looking at this graphic.
Since picking up if the growth rates of M1, M3 and CPI follow similar trends over time is pretty hard to do looking at the above graphic, we will take the average annual growth rate of all these variables and compare them to one another and then calculate correlations in order to determine whether they are correlated (move in similar directions over time).
Again as was evident with the line graph, the growth of notes and coins in circulation is far greater than that of overall money supply in South Africa and is far higher than the official inflation rate in South Africa. But the question now is whether they move in similar directions over time? The table below shows the correlation between the various variables and CPI. Both without a lag applied and with a one year lag applied. With the lag we are saying it takes a year for the movement in either M1 or M3 to have an impact on the CPI. Results and its dicussion below.
Variable |
Correlation (No lag) |
Correlation (1 year lag) |
M1 |
0.72 |
0.23 |
M3 |
-0.37 |
0.19 |
The table above shows that there is a 72% correlation between the annual growth in M1 (notes and coins in circulation) and the annual inflation rate experienced by the South African economy. Not we are not saying an increase of 100% M1 is leading to a 72% increase in inflation. We are merely stating the growth rates follow a very similar trend. And the strength of that similarity in trend is 72%. M1 might be increasing due to inflation increasing as more money is needed to pay for more expensive goods. Or inflation might be increasing due to excess notes and coins in circulation. Regression analysis will have to be done to test for causality. In order to determine which of the two is the cause and what is the effect.
However when looking at M3 (notes and coins in circulation + short term deposits etc), without a lag applied there is a negative correlation between M3 money supply and the inflation rate. A relatively strong negative correlation of -37%. Thus saying that the growth rates in M3 and CPI is not similar or correlated and infact they tend to move in opposite directions.
With a one year lag applied however this negative correlation of -37% turns into a positive correlation of 19%. Thus showing that the growth rates in M3 has a stronger correlation to growth rates in inflation if the data is lagged. I.e we compare 2016 growth in inflation to the 2015 growth rates of M3 money supply.
When M1 money supply is lagged by a year the extremely strong correlation of 73% is now only 23%. Clearly showing that applying a lag to M1 money supply leads to a far weaker correlation between inflation and money supply.
While the above provides anicdotal evidence that money supply growth could be influencing the inflation rate more rigourus testing is required to quantify the relationship better.
But what readers can take away from this is that there is roughly R1.6trillion in notes and coins in circulation of the South Africa rand. And according to the South African Reserve Bank (SARB) the same R20 note that you spend on coffee today will eventually be used roughly 3 times during the year. The graphic shows the "velocity" of notes and coins (M1) from 2010.
However when looking at M3 (notes and coins in circulation + short term deposits etc), without a lag applied there is a negative correlation between M3 money supply and the inflation rate. A relatively strong negative correlation of -37%. Thus saying that the growth rates in M3 and CPI is not similar or correlated and infact they tend to move in opposite directions.
With a one year lag applied however this negative correlation of -37% turns into a positive correlation of 19%. Thus showing that the growth rates in M3 has a stronger correlation to growth rates in inflation if the data is lagged. I.e we compare 2016 growth in inflation to the 2015 growth rates of M3 money supply.
When M1 money supply is lagged by a year the extremely strong correlation of 73% is now only 23%. Clearly showing that applying a lag to M1 money supply leads to a far weaker correlation between inflation and money supply.
While the above provides anicdotal evidence that money supply growth could be influencing the inflation rate more rigourus testing is required to quantify the relationship better.
But what readers can take away from this is that there is roughly R1.6trillion in notes and coins in circulation of the South Africa rand. And according to the South African Reserve Bank (SARB) the same R20 note that you spend on coffee today will eventually be used roughly 3 times during the year. The graphic shows the "velocity" of notes and coins (M1) from 2010.
Higher rates of velocity shows economies further along business cycles (positive growth) while lower velocity rates generally shows economies that are struggling or exhibiting slower growth rates. And the above is further proof of how much the South African economy is struggling.