The money supply can be broadly defined as consisting of currency and deposits. While currency forms but a small portion of the total money supply, it can be a crucial determinant of spending behaviour and subsequently economic activity. The ability of the money supply to predict an up- or downswing in economic activity, as measured by a positive or negative output gap, is evaluated over a sample period 1980 – 2012. Two models are estimated, one using only the currency component and a second using the total money supply (M3). It is found that the growth rate of real currency in circulation is reasonably accurate in predicting economic activity 6 months ahead, whereas the total money supply can predict economic activity up to 9 months ahead. It is concluded that currency in circulation can be a valuable additional source of information to policymakers and can complement other approaches of forecasting economic activity.
Can currency in circulation predict South African economic activity?
Working paper 582
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