By Ryland Thomas of the Bank’s Monetary Assessment and Strategy Division.
Broad money is at the heart of the monetary transmission mechanism and consequently plays an important role in the assessment of inflationary pressures. This article examines the factors behind stronger broad money and credit growth in 1995, using recent econometric research undertaken at the Bank.
Broad money has played an important role in the formulation of monetary policy in the United Kingdom over the past 25 years. Between 1976 and 1986, targets were published for various definitions of broad money. And within the current monetary framework (announced in October 1992) there is a monitoring range of 3%–9% for the annual growth of the M4 measure of broad money. The role of broad money is primarily to provide information about future movements in nominal demand and inflation along with a wide range of other indicators. So, for example, Section 2 of the Bank’s Inflation Report pays close attention to developments in broad money and credit in the context of the government’s inflation target.
During 1995 the twelve-month growth rate of broad money increased steadily, rising above the upper limit of the M4 monitoring range. Recent Inflation Reports have identified this as a source of upside risk to the government’s inflation target should such growth persist. This article analyses in more detail the factors underlying broad money growth in 1995, and the wider role of broad money in the transmission mechanism of monetary policy. It uses recent Bank research on the determinants of M4 to address these issues.