Eurozone six-month real M1 expansion – the best monetary leading indicator of the economy – fell back in September but remains solid at 2.0% (4.1% annualised). It continues, in other words, to suggest a recovery in region-wide economic activity in late 2012 / early 2013.

Peripheral real M1 deposits fell in the six months to September but the pace of contraction has slowed.

Peripheral real M1 deposits, indeed, rose in August and September – the following chart shows monthly movements. The six-month change may well turn positive in October as a large April decline drops out of the comparison.

Among the large economies, the key trends are German strength, Italian improvement and Spanish weakness. The six-month changes in real M1 deposits in Italy and France are now similar. With the ECB’s OMT backstop in place, a 270 basis point spread between 10-year Italian and French government yields may not be warranted by Italy’s higher debt level. (General government debt amounted to 126.1% of GDP in Italy and 91.0% in France at the end of the second quarter, according to Eurostat. The IMF projects a general government deficit of 2.7% of GDP in Italy in 2012 versus 4.7% in France.)

The better-than-expected third-quarter GDP result is consistent with the forecast here that the economy would regain momentum during the course of 2012 in lagged response to faster real money supply growth since late 2011 – see, for example, a post in May. With monetary trends improving further in recent months, this upswing should be sustained at least through next spring – see chart.

The 1.0% quarterly rise is flattered by an unwind of the Jubilee bank holiday drag in the second quarter and a probable positive net impact from the Olympics / Paralympics. Most of the holiday distortion can be removed by comparing the third-quarter GDP level with the first rather than second quarter. If the third-quarter result is assumed to have been inflated by 0.2% because of the Olympics / Paralympics, “underlying” GDP was 0.4% higher than in the first quarter, following a 0.7% fall over the previous two quarters (i.e. between the third quarter of 2011 and first quarter of 2012).

A 0.2% Olympics / Paralympics boost takes into account the direct impact of ticket sales but assumes that other positive effects displaced activity elsewhere in the economy. This seems consistent with official “nowcasts” of output in the services, industrial and construction sectors in September (i.e. after the Olympics had finished) incorporated in the third-quarter GDP estimate – the implied monthly level of GDP is 0.2% below the quarterly average.

The strong third-quarter GDP rebound confirms that the second-quarter fall was entirely due to the bank holiday distortion. The economy, in reality, contracted in only two quarters – the fourth quarter of 2011 and the first quarter of 2012. GDP fell by 0.4% and 0.3% in the two quarters, or only 0.2% and 0.2% excluding oil and gas production. While satisfying the commonly-used “two-quarter rule”, it is questionable whether this period of weakness really qualifies as a “recession”, in the sense of a “pronounced, pervasive and persistent” decline in economic activity – particularly in view of the resilience of the labour market.

Today’s news supports the forecast here that the MPC will pass on more QE at its 7/8 November meeting, barring external calamities.

An October rise in the “flash” manufacturing PMI produced by private research firm Markit suggests that the Chinese economy is slowly regaining momentum, consistent with faster real M1 expansion since the spring – see previous post. The key new orders index remains below the supposedly “breakeven” 50 level (49.7) but similar readings historically have been associated with respectable industrial output expansion – see first chart. (The “official” PMI produced by the National Bureau of Statistics – regarded here as more authoritative than the Markit version – will be released at the start of November.)


The scenario of a turnaround in China lifting regional activity is supported by a sharp fall in the proportion of Asian equity analysts downgrading company earnings forecasts in September and October – analysts should reflect firms’ own views about the sales / profits outlook. The “revisions ratio” (i.e. the net proportion of forecasts upgraded over the month) for companies in the MSCI Far East excluding Japan index reached a 19-month high in October, suggesting a reversal of recent weakness in industrial output – second chart.


There was less promise in Eurozone flash PMI and German Ifo surveys for October also released today – headline measures undershot expectations. The Eurozone manufacturing new orders index, however, is holding just above a low reached in May, while Ifo manufacturing expectations rose marginally, breaking a five-month string of declines – third chart. Solid German real money growth continues to suggest that industrialists’ angst is exaggerated and the economy will improve significantly by early 2013 – fourth chart. (September money numbers are due for release tomorrow.)


The UK CBI manufacturing survey for October was mixed but on balance encouraging, with the expected output balance at its highest since April 2011 – fifth chart. (Such expectations are a better leading indicator of activity than order books, which weakened sharply.) Price-raising plans, however, rebounded, signalling a probable reacceleration of CPI goods inflation into early 2013 – sixth chart.

The hopeful message for the global economy from monetary and leading indicator data – see yesterday’s post – contrasts with consensus gloom, epitomised by the IMF’s latest World Economic Outlook (WEO), containing downgrades to the organisation’s global GDP growth projections for 2012 and 2013. The IMF claims that fiscal consolidation is exerting a much larger drag on economic expansion than previously assumed by itself and other forecasting bodies. Analysis by its chief economist, reported in Box 1.1 on page 41 of the WEO, suggests that the “fiscal multiplier” – the percentage impact on GDP of a change in the “structural” budget balance of 1% of GDP – averaged as much as 1.7 across a group of 28 economies in 2010-11, compared with an expectation among forecasters of about 0.5.

Fiscal tightening is scheduled to continue in 2013, with the IMF projecting a 1.0%-of-GDP fall in the structural deficit of advanced economies. If the fiscal multiplier were really 1.7, this would imply “fiscal drag” of 1.7% of GDP – probably sufficient to neutralise or outweigh stimulus from faster real money expansion. On closer inspection, however, the analysis generating the 1.7 estimate turns out to be suspect, relying heavily on results for two small countries. A defensible reworking of the numbers suggests that the prior hypothesis of a multiplier of “only” 0.5 cannot be rejected by standard statistical tests.

The 1.7 estimate is based on a comparison of deviations of GDP growth from forecasts over 2010-11 with projected changes in structural budget balances. Using the IMF’s own numbers, the best-fit line drawn through the associated scatter chart has a slope of -1.2, implying that fiscal tightening of 1% of GDP was reflected in a growth undershoot of 1.2% relative to forecast, on average. This 1.2 estimate must be added to the sensitivity of about 0.5 incorporated in the growth projections, implying a “true” multiplier of 1.7.

One oddity of the IMF’s analysis is that, while claiming to investigate the impact of fiscal consolidation, it includes eight countries whose structural budget balances actually worsened in 2010-11. Restricting the sample to only those countries that tightened fiscal policy, in fact, has no impact on the estimated “true” multiplier; the slope of the relationship is unchanged at -1.2 – see the red line in the chart below.

The chart, however, makes clear the dependence of this result on two “extreme” observations towards the bottom, for Romania (middle) and Greece (right). When these two countries are omitted, the estimated slope falls to -0.3 and is not statistically significant – green line. The claim, in other words, that the true multiplier is greater than 0.5 rests entirely on developments in Greece and Romania in 2010-11.

Significant fiscal tightening has clearly contributed to a deep Greek recession but it is impossible to disentangle this from the impact of a slump in the money supply caused by capital flight and lack of monetary policy autonomy – Greek narrow and broad money fell by 22% and 24% respectively in the two-years to end-2011. There has been no such money supply contraction in Romania but nor has the economy been notably weak – GDP expanded by 0.2% in 2010-11 combined. The undershoot relative to forecasts may simply reflect unwarranted IMF growth optimism in 2010.

Summing up, the IMF’s bold claim about the fiscal multiplier has provided a publicity coup for Keynesians but rests on flimsy statistical foundations. Fiscal tightening will exert a modest drag on global GDP growth in 2013 but real money supply developments should continue to drive the economic cycle, with recent trends warranting optimism.

Based on available information, six-month expansion in global real narrow money – the best longer-term leading indicator of economic growth – probably rose further in September, reaching its highest level since January. Allowing for the typical half-year lead, this suggests that an incipient upswing in global economic momentum will be sustained at least through March 2013 – see first chart.

September monetary data have been issued for the US, Japan, Brazil, China and India, together accounting for 60% of the G7 plus emerging E7 aggregate used here to proxy the global money supply. Faster US and Chinese real money expansion drove the suggested increase in the global measure last month – second chart. Eurozone numbers due on Thursday will be important for the final outcome but are very unlikely to show sufficient weakness to offset the US / Chinese increases.

The positive signal from real narrow money has received confirmation from a recent upturn in a shorter-term global leading indicator employed here – see previous post. A further recovery in new orders components of October manufacturing purchasing managers’ surveys would provide additional support for the suggested economic scenario; “flash” readings for China, Euroland and the US are released on Wednesday. Based on equity analysts’ earnings revisions, a rise in the G7 new orders measure above the breakeven 50 level looks possible – third chart.