RDP 8803: Do Financial Aggregates Lead Activity?: A Preliminary Analysis 5. Concluding Comments

This study has attempted to establish whether financial aggregates are leading or lagging indicators of economic activity in Australia. The main findings can be summarised as:

• turning points in nominal private domestic final spending are more often than not followed by turning points in broad financial aggregates.
• in general, lags of nominal activity variables tend to be correlated with current movements in money and credit, and not the reverse;
• on VAR analysis, there is evidence that lags of real and nominal activity variables help explain movements in money and credit aggregates (except M3), but little evidence of the reverse;

The poor results for M3 – it neither “Granger-causes” anything nor is Granger-caused by anything – are surprising at face value. But this does not necessarily mean that there is no relationship between M3 and economic activity – only that whatever relationship there is is fully reflected in the information from lags of M3 itself – lags of activity do not add any further explanation.

On balance, the analysis suggests, then, that money and credit aggregates are probably contemporaneous or lagging indicators of activity. While the structural relationship between financial aggregates, activity and interest rates is no doubt complicated, the implications of this paper are that observed changes in monetary and credit aggregates most likely indicate what is happening and has already happened in the real economy, not what is about to happen.

There is still some value in monitoring such aggregates. Comprehensive information on economic activity typically becomes available on a quarterly basis, in the national accounts, with a lag of two or three months. Information on financial aggregates becomes available monthly, and with a shorter lag. Provided that the lag from activity to money and credit is not too long, information on financial aggregates can be used, along with partial indicators of activity, to assess what is happening to economic activity.