The monetization of economy: An indicator that indicates nothing

Abstract

The indicator of monetization of the economy; equal to the ratio of nominal money supply to nominal GDP; is very popular among Russian economists and is used to assess the effectiveness of the monetary policy pursued and is often employed in cross-country comparisons. Many economists believe that the monetization of the Russian economy is excessively low; which reflects the underdevelopment of the national financial system and requires steps towards monetary expansion. According to this view insufficient monetization of the Russian economy is as an obstacle to its rapid development; therefore increase in monetization should be made a key priority of the Bank of Russia’s policy. Although widely accepted; the complex of theories; ideas and assumptions behind these recommendations; however; has never been adequately empirically tested. In this paper we formulate several statements that are shared by the majority of economists in this area; based on a review of relevant publications; and then test the statements on cross-country data. As a result of empirical testing; it was shown that most of the statements are not supported by evidence. The monetization indicator does not carry any additional relevant information about the macroeconomics conditions; having other indicators considered. High monetization does not create additional stimulus for economic growth; and the ability of central banks to affect monetization is limited significantly. In countries with low monetization; inflationary risks of monetary expansion are sharply higher. The conducted empirical study provides arguments against the broad use of the monetization indicator in macroeconomic analysis and casts doubt on the idea of laying responsibility for increasing the level of Russian economy monetization on the Bank of Russia.