August 22, 2012 Reading Time: 2 minutes
Slumping Money Supply

Hungary is in a recession, again. According to the chattering classes, as well as many analysts and financial reporters, fiscal austerity is the cause of Hungary’s slump.

Nonsense. Hungary’s recession results from its slumping money supply.

When monetary and fiscal policies move in opposite directions, the economy will follow the direction taken by monetary (not fiscal) policy – money dominates. For doubters, just consider Japan and the United States in the 1990s. The Japanese government engaged in a massive fiscal stimulus program, while the Bank of Japan embraced a super-tight monetary policy. In consequence, Japan suffered under deflationary pressures and experienced a lost decade of economic growth.

In the U.S., the 1990s were marked by a strong boom. The Fed was accommodative and President Clinton was super-austere – the most tight-fisted president in the post-World War II era. President Clinton chopped 3.9 percentage points off federal government expenditures as a percent of GDP. No other modern U.S. President has even come close to Clinton’s record.

The money supply picture for Hungary seemed to be looking up until late 2011 (see the accompanying chart). Indeed, Hungary’s money supply had nearly returned to its trend-rate level, when it peaked in November 2011. Then, in the course of just over a month, things took a turn for the worse.

First, Moody’s downgraded Hungary’s debt to junk status, and soon thereafter, S&P and Fitch followed suit. Then, the EU and IMF walked out on debt restructuring talks, citing concerns over proposed constitutional changes, which threatened the Hungarian central bank’s independence. Just days later, their fears were confirmed, as the Hungarian Parliament passed the controversial law, merging the central bank with the Financial Supervisory Authority. And, to top it off, Hungary unexpectedly cancelled part of its December debt auction.

When the dust settled, confidence in Hungary’s financial system had been shattered. Despite a 15.9% increase in the supply of state money, the total money supply had plummeted by 4.2% (from November 2011 to January 2012). As the accompanying table shows, this decline in the total money supply was driven by a 9% drop in the all-important bank-money component of the total.

Hungary’s money supply has yet to recover from this perfect monetary storm. And, as if that wasn’t enough, Hungary recently adopted a damaging financial transactions levy.

Money and monetary policy trump fiscal policy. Until Hungary gets its money and banking houses in order, its economy will continue to wallow in recession.

Read the original article here

Steve H. Hanke

Steve-H-Hanke

Steve H. Hanke is a Professor of Applied Economics and Founder & Co-Director of The Johns Hopkins Institute for Applied Economics, Global Health, and the Study of Business Enterprise. He is a Senior Fellow and Director of the Troubled Currencies Project at the Cato Institute, a contributor at National Review, a well-known currency reformer, and a currency and commodity trader.

Prof. Hanke served as a Senior Economist on President Reagan’s Council of Economic Advisers in 1981-82, a Member of the Governor’s Council of Economic Advisers in Maryland in 1976-77, and a Senior Advisor to the Joint Economic Committee of the U.S. Congress in 1984-88. He has been an adviser to five foreign heads of state and five foreign cabinet ministers and held a cabinet-level rank in both Lithuania and Montenegro. He has been awarded seven honorary doctorate degrees, and is an Honorary Professor at four foreign institutions. He was President of Toronto Trust Argentina in Buenos Aires in 1995, when it was the world’s best-performing mutual fund. Currently, he serves as Chairman of the Supervisory Board of Advanced Metallurgical Group N.V. in Amsterdam.

In 1998, he was named one of the twenty-five most influential people in the world by World Trade Magazine In 2020, Prof. Hanke was named a “Knight of the Order of the Flag” by Albanian President Ilir Meta.

Get notified of new articles from Steve H. Hanke and AIER.

Related Articles – Central Banking, Fiscal Policy, International, Monetary Policy, Sound Money, Sound Money Project