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The Real Reason Why M3 is Abolished

January 14, 2006

I have so far not commented on one of the strangest developments in the world of statistics-how the Federal Reserve have decided that the M3 measure of money supply will be "discontinued" without saying why . Since they came with no explanation there have been lots of speculation as to why they did it.

It certainly wasn't because the Fed Governors on aprioristic essentialist grounds decided M2 better reflected true money supply. Nor was it because M3 correlates less with GDP and financial market activities than M2, in fact it usually correlates more.

So why did they do it ? Hard money writers have offered a variety of possible reasons, but I think it all comes down to one thing: M3 have during the last few years increased more than M2. Just like the Fed and pro-administration pundits makes sure to focus on whatever consumer price measure increases the least (currently the "core" PCE deflator), the Fed wants people to focus on a money supply measure which increases less.

We can see that during the latest year, M3 increased 8.4% versus only 4.8% for M2. This discrepancy is not new, as during the last 10 years, M3 increased at a average annual rate of 8.2% versus 6.3% for M2. These numbers really say everything we need to know about the Fed's motive.

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