The monetary and fiscal tightening gauge is based on government spending and central bank policies regarding the availability of cash and the interest rate target. Policies are expansionary when government spending increases as a percent of GDP (including increased deficit spending), and when the central bank increases the money supply or lowers interest rates. Policies are contractionary when the government decreases spending as a percent of GDP, and when the central bank reduces the money supply or raises interest rates. Finesse constructs a monetary tightening gage with the following three indicators: (1) the 12-month change in Money Supply as a % of GDP, with higher values indicating expansion and lower values indicating tightening; (2) the 12-month change in government spending, with increasing deficit spending indicating expansion, and a budget surplus indicating contraction; and (3) the 12-month change in the short-term interest rate, with decreasing rates indicating expansion, and increasing rates indicating contraction. In the graph, Lower numbers indicate tightening, and higher numbers reflect looser monetary conditions.
Money supply measures the amount of cash in the economy, with designations ranging from M0 to M3 where each successive number includes the lower number designations (i.e., M1 includes M0, and M2 includes M1 & M0, etc.). M0 includes bank reserves, both required and excess, plus cash and coins in circulation. M1 includes money in checking accounts (demand deposits) and travelers checks. M2 includes savings accounts, money market accounts, and CDs under $100,000. M3 includes CDs over $100,000. Economist Milton Friedman asserts money supply is directly tied to inflation, “Inflation is always and everywhere a monetary phenomenon in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output.” (The Counter-Revolution in Monetary Theory, 1970). Not all economists agree.
Nominal values in economics refer to the unadjusted rate or current price, without taking inflation or other factors into account. Compare to Real (Inflation-Adjusted) values, where adjustments are made for inflation to the change in the general price level over time.
