Is the Money Gap a Misleading Measurement of Excess Liquidity?

Liquidity status can impact monetary policy decisions and therefore the macroeconomic framework as a whole. This highlights the importance of accurately defining the liquidity status of the economy at any point of time. The ‘money gap’ concept is gaining attention and being employed to measure excess liquidity. The purpose of this article is to investigate whether the ‘money gap’ in this regard is reliable or not. Our methodology consisted of two stages. The first was a critical literature review of the different interpretations of the ‘money gap’. The review revealed that; the money gap, as a measurement of excess liquidity, is misleading. This is because, it benchmarks liquidity status to a base period or to long term equilibrium; both benchmarks don’t reflect the current macroeconomic needs. Therefore, we moved to stage two; we developed a framework of analysis to inform monetary authorities, in inflation targeting regimes, regarding current liquidity status. This framework didn’t only consider the Marshallian K, in liquidity analysis, as established in literature, but also, originally, simultaneously considered the inflation level relative to the target. This is through linking the different possible values of the Marshallian K to the different possible levels of inflation in an inflation targeting regime. Such linkage enabled to classify, within each liquidity status, different levels of inflationary pressures. This framework can help monetary authorities, in inflation targeting regimes; accurately timely define liquidity status and the relative level of inflationary pressures, this is to make accurate timely policy choices, especially needed in crisis time.