I agree with you that a definition of money is intrinsically impossible, and that there is no such thing as an accurate, exact ‘Money supply’ figure. But the point of money is to be a store of value, and the point of inflation is a measure of how well that store of value works over time. So as you say, the crucial question, is about how money supply affects behaviour (which inconveniently is also impossible to define or measure), and whether it causes inflation.

So we’ll never get an answer to the question (exactly how big is our money supply), but given that money is our universal measure of equity, reward and justice, isn’t that enough to just declare, that even an imperfect estimation of money supply tells us something useful?

My problem then, is not whether all bank deposits fit any arbitrarily chosen definition of ‘money’, but whether people behave as though those deposits have monetary value, and spend accordingly. If they do, I find it hard to see how increasing money supply doesn’t automatically (with some lag) cause inflation. Indeed I find the Austrian’s arguments that increasing money supply IS itself inflation quite convincing.

And BTW M3 here does not include repo’s or most ‘eurodollars’ (foreign held $A), which IMO makes it more like the US M2. Not that that’s critical, but the RBA does do things it’s own way. We might as well know what we are comparing (and it’s unfortunately not easy to find out that info).

You mention the velocity of money. Do you feel that explains the disconnect between M3 and the CPI?

Money that’s locked away still matters. If people have ‘money in the bank’ or a large credit limit at their disposal, it influences their consumer behavior. This ‘money’ means people spend more, with an inevitable effect on inflation.

I have also mentioned it elsewhere on this blog.
This, to me, is the crucial question – how does all this affect the behaviour of the actors in our economic framework? To me, getting an exact number for the money supply1 is far less important than working this out.
Perhaps I should have titled this post “What is the Money Supply and Why does it matter?”, to which my answer, at the moment, would be “We have a vague idea” and “Only in how it affects behaviour”.
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1. Even if possible – and I would propose it is not as by the time you calculate it, it will have changed not only in quantum, but in definition.

Isn’t it true that since I can use my EFTPOS card to pay for bread at Woolies, then numbers in my cash account are effectively the same as cash in my hand? Albeit, I can only use these numbers to buy from people with EFTPOS machines. But for most purchases, especially large ones, this is true.

A term deposit is different. I can’t buy bread directly with it. But I can list term deposits as assets when asking for a loan, and mentally, when I’m walking past the eight pair of jeans I don’t need, somewhere in the back of my head I’m including that term deposit in my general sense of wealth. At Harvey Norman, I can ‘spend’ that term deposit now, knowing that I have 2 years to front up with the cash.

My credit card even allows me to spend money I don’t have, that presumably gets created the minute I press ‘OK’. Therefore, my credit limit is arguably a part of the money supply.

Money that’s locked away still matters. If people have ‘money in the bank’ or a large credit limit at their disposal, it influences their consumer behavior. This ‘money’ means people spend more, with an inevitable effect on inflation.

And as far as the disconnect between Money Supply and Inflation goes, there is another explanation. Not only does CPI ignore assets – a huge soak for money, but hedonic effects, geometric calculations, and substitution (the fixed basket that is not fixed) have changed the way the CPI is calculated. They all reduce the CPI result.

John Williams at Shadow Statistics has done the detailed-number-crunching job of recalculating today’s US CPI rate according to methods used in the pre-Clinton era. If we ignore all the CPI method changes since 1992, current CPI is over 7%. http://www.shadowstats.com/

This article sums up why the CPI figures don’t ring true to the money supply figures any more.
http://www.weedenco.com/welling/Downloads/2006/0804welling022106.pdf

Joanne

Obvisouly, as you point out, the money is not sitting idle in the vault. It has been lent out to some better use, while you don’t need it. And that how banks create money, through fractional reserve banking. This is captured in the definition of ‘broad money’. Here is how the RBA defines it: http://www.rba.gov.au/Glossary/detail.asp?offset=40&term=broad%20money

But not only banks and governments create money. Anyone collecting rights against its obligations, i.e assets against liabilities, in essence, creates money. Companies, when issueing stock to fund their investments, for instance, create money. And who’s to say stocks don’t work as money? People get paid in stock! And stock options!! BHP share certificates are no less money than the RBA’s money bills. As long as they can both be exchanged for something else, they work as reserve of value and means of exchange. The difference, of course, as you rightly point out, may be in liquidity. But information technology has made the transfer and trade of practically any asset just as seamless as that of money.

Is this useful? I think so. When leverage is higher than growth, i.e. when we promise more than we can deliver, those promises, those IOUs we call money, become cheap. And it’s when we all start failing to deliver on our promises that things begin rolling downhill. Further, whoever laughed last, laughs least! Cheap money fuel dear assets, i.e. asset inflation. Those relying on salary, those company IOUs, to make ends meet will see everything around them going up – property, stocks – and will rush to save and jump on the get-rich-fast bandwagon. Who can blame them? If they don’t, they are left behind, everything went up but theirs, and the alternative to catching-up-to-the-joneses turned out to be the get-poor-even-faster. The trouble is that by the time they manage to get in, those that were already there from the beginning move out to make room, selling them their seat for something a little less fleeting (gold, anyone?).