What is monetarism and what happened to it?

In the late 70s and early 80s economic monetarism was espoused by Margaret Thatcher and Sir Keith Joseph  who wanted a radical alternative to the prevailing Keynesianism of previous governments. The theory seemed to be simple enough. The idea was that the money supply was a key parameter of our economy. Therefore, if we wanted to control inflation, and it did need to be controlled at the time, all Government needed to do was control the supply of money. Inflation would then fall and all would be well. Very quickly the Government and Treasury economists learned that they could not actually do that. It was difficult enough to define what money actually was let alone control the amount of it. Is it base money M0, which is just the amount of notes and coins in circulation? Or is it M1 which includes travellers’ cheques and demand deposits? Or, maybe M2 which includes savings deposits? Or M3 or M4?  For anyone who cares to look it up they can find out what MZM means. There are lots of ways we can create money and lots of ways to try to define it. If I write out an IOU that is a form of money. As Minsky famously said, anyone can create money. It is getting it accepted which may be the problem.

But if we think about it, we can see that the money supply, no matter how we define it, does not tell us anything much at all. If the Bank of England were to, say,  create £10 trillion of banknotes and keep them securely in their vaults they would have absolutely no effect at on the economy. But if they were stolen and scattered around the country by dropping them from a proverbial helicopter then they certainly would have an effect. They would be spent. So it is not so much the amount of money that exists that matters. It is the amount of money that is spent.

So Mrs Thatcher and her new government very quickly had to come up with a way a making ‘monetarism’, which was clearly an incorrect economic theory, actually work. They did this by changing quietly to what might be termed “interest-rateism”. Anyone who had just bought a house for the first time then will perhaps remember paying mortgage interest rates of 16%.  In doing so they became just as Keynesian as any previous government. There is no dispute from Keynesians that one important economic lever is the control that Government has over interest rates. The dispute, amongst Keynesian economists of varying views, is over the extent to which it should be used. The monetarists have since morphed into so-called New Keynesians who do argue that the interest rate lever should be the main, if not the only, control exercised by governments. It is now almost always assumed by economic pundits on the TV that monetarism and interest-rateism are one and the same thing. We should question that.

To look at how it works in our present day economy which has a GDP of £2.051 trillion per annum,  we need to start by acknowledging that it needs at least £2.051 trillion p.a. of total spending to keep it going. This will be a mixture of public and private spending.  However, if it is a lot more than that we are going have too much inflation. If it is less than that we have recession and deflation as manufactured stock doesn’t clear. In practice we should aim for just slightly more (maybe about 4% more) than £2.051 trillion to achieve a target of something like 2% inflation plus 2% growth. Admittedly this can be a tricky balance to get right.

The idea that we can fine tune the required spending in the economy by adjusting interest rates alone is nonsense and it is becoming ever more nonsensical as interest rates tend downwards towards zero. It might make sense to cut interest rates from 6% to 5%, say, and expect some degree of success. It doesn’t make sense to cut them from 0.5% to 0.25% and expect total spending to change as the Government might wish.

The fine tuning we desperately need can only be done by sensible fiscal adjustment. ie varying Government spending and taxation. Not to ‘balance the books’ – that’s never a problem for a currency issuer – but to balance the economy. In other words we need to steer a sensible middle course between, on the one hand, having too much inflation and too high a level of unemployment/ business failures on the other.

* Peter Martin is not a LibDem party member but has voted LibDem in previous elections.

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36 Comments

  • Eddie Sammon 23rd Aug '16 - 3:32pm

    Good topic to discuss. I’m a bit of a monetarist because as I’ve said plenty of times: I’m against the ultra low interest rate consensus and monetarism is associated with higher interest rates.

    People say the stock market will crash if we increase rates, but it is at record highs so we can afford a bit of a dip. The US are considering a rate-rise next.

    Look at the Japanese asset bubble burst and their “lost decade” – that was partly the fault of an interest rate cut and so was the US housing bubble after the dot.com crash. Although I agree perhaps a 3% long term norm is better than the previous 5%.

    It also depends what we include in the inflation figures: if we include the prices of houses and pension annuities then the inflation figures look very different.

  • I’ve never been a fan of monetarism for the reason outlined in this article.

    Eddie
    I don’t think interest rates are low to protect the stock market. I think it’s more down to keeping the balance of debt repayment low and to protecting the housing market. It seems to me that low interest rates are a semi-permanent solution to over valued/priced assets. The thing about debt is that if it stops being paid off it becomes a loss and low interest rates thus at least keep things ticking over.

  • Eddie Sammon 23rd Aug '16 - 4:36pm

    Glenn, true, but I think the stockmarket is part of it, it’s why bankers love quantitative easing so much. I’ve called for QE once when pensions were getting hammered, but there’s space for the opposite now, in my opinion.

  • But if we think about it, we can see that the money supply, no matter how we define it, does not tell us anything much at all. If the Bank of England were to, say, create £10 trillion of banknotes and keep them securely in their vaults they would have absolutely no effect at on the economy. But if they were stolen and scattered around the country by dropping them from a proverbial helicopter then they certainly would have an effect. They would be spent. So it is not so much the amount of money that exists that matters. It is the amount of money that is spent.

    But… surely when a monetarist says that what is important is ‘the money supply’ they mean by that ‘the amount of money in circulation’? Money sitting in vaults isn’t part of ‘the money supply’ in any real sense, so no monetarist would count it as having any bearing on monetary policy.

    I mean, you seem to agree with the monetarists that adjusting the money supply upwards would have an effect, specifically an inflationary effect. So in that sense are you not agreeing with monetarism?

    And if adjusting the money supply upwards would have an inflationary effect, does it not follow, as the monetarists say, that the corollary is that if you want to bring inflation down you want to adjust the money supply downwards?

    So far I can’t see what’s wrong about monetarism.

    So Mrs Thatcher and her new government very quickly had to come up with a way a making ‘monetarism’, which was clearly an incorrect economic theory, actually work. They did this by changing quietly to what might be termed “interest-rateism”

    But it’s not an incorrect theory, as you admit when you say that increasing the money supply (by dropping banknotes form helicopters) would have an inflationary effect, as predicted by monetarism.

  • Surely the reason that Thatcher et al became obsessed with interest rates is not that monetarism is wrong but that it is difficult to implement in the reverse direction: while it is relatively easy to adjust the money supply upwards and have an effect (print notes, drop from helicopters) it is much more difficult to adjust the money supply downwards. Interest rates are one of the few levers you have to take money out of the economy.

    And at a time when the main problem was high inflation, it was a downward adjustment in money supply which was needed: hence, the obsession with interest rates.

    Of course there’s a limit to how far the interest rate lever goes, and we’ve just about hit it now with 0.25% rates. But that doesn’t mean the basic monetarist thesis, ‘adjust the money supply downwards to control inflation’, was wrong, it just means that there is a limit to how much interest rates can do that adjustment.

    The fine tuning we desperately need can only be done by sensible fiscal adjustment. ie varying Government spending and taxation

    But surely spending and taxation, if balanced (ie, you spend what you take in in tax) will be neutral? That is, if you up taxes, then people have less money to spend, okay, so that will have a counter-inflationary effect. However, wont’ that be offset by the fact that you then spend the money, which gives it to other people, who spend it, with the resultant inflationary effect?

    Contrariwise, if you were to cut government spending, you might expect an anti-inflationary effect as people on the public sector payroll have less money. But, as long as the savings are used to cut taxes, won’t that be offset by the extra spending by people who are now not paying as much tax?

    It seems the only way for taxation and spending to have an effect is if the two are not symmetrical, ie, either you tax money and don’t spend it (and use it either to pay down the debt, or simply hoard it) or you spend more money than you raised in taxes (presumably making up the shortfall by borrowing externally, although that is not sustainable forever).

  • But the BoE are not just altering interest rates they are also printing ‘helicopter’ money in what used to be called devaluation but is now called QE. This is of course just another stealth tax.

    However our big problem is not so much the amount of money we earn as the amount we need in order to live in the UK and top of that list is housing cost. Imagine just how much spare money we’d have if housing was affordable. Of course that won’t ever happen because those already at the top of the housing ladder would prevent it. Somehow we became a country that thought of housing as an investment rather than just a place to live. Alas our local planning depts and faux-green objectors are complicit with the landowners in making a bad situation worse.

  • Steve Trevthan 23rd Aug '16 - 6:27pm

    As about 97% of our money is created by banks on computer screens and is effectively a record of debts issued by said banks, how can our economy do better than break even?
    Finance and economics are massively multi-factored. Significant factors appear to include, the driving down of the price of labour/”real-life goods and services pay”* as a result of Globalisation,the preferences given to the financial sector by governments, the exponential growth of an unregulated derivatives market-casino and the off-shoring of tax responsibilities.
    Economic factors indicate a continuing period of low inflation and our money is only “monetised debt/fiat money. So what are the objective obstacles to our government and/or its institutions taking direct, lower cost responsibility for the issuance of money instead of the current higher cost, lower responsibility approach?
    Our economy needs greater aggregate demand. Demand, which requires potential customers to have more than “austerity money”, precedes supply. The money has to be out there searching for goods and services before employers will add more well paid workers to create the aggregate demand required for a robust “real economy.” Money can and should be added to the point of full capacity and stopped before more will drive up prices.[From Ellen Brown: The Web of Debt] This is why direct money issuance is more efficient and more responsible than the current indirect system through the banks whose principal concern, reasonably enough, is their balance sheets.
    Alas, if the unstated aim of government is to have citizens who are so concerned about debt and the insecurity of employment that they are cheap, disposable and biddable,
    there is no real governmental wish to make the economy buoyant.
    A policy is what actually happens which may or may not be what we are told.

    *That is the pay of much the most of us.

  • Peter, would a Monetarist claim that if £20bn is added to the economy via a tax cut the effect will be the same regardless of where the money went? For example, would they claim that giving it to the richest 1% who “invest” it or transfer it to a tax haven has the same effect as giving it to the poorest 25% who spend it on more food, cloths, a secondhand car or their home. Or is it just that the latter creates growth and the former inflation?

  • Bill le Breton 23rd Aug '16 - 9:19pm

    Anyone who is interested in this subject but has no background in the subject AND who has half an hour spare could do a lot worse that listen to Prof Nick Rowe give a basic run through here – he’s really good at using metaphors that help explain things: https://soundcloud.com/macro-musings/nickrowe

    Your discussion above has covered some issues around the supply of money, but you really have to add ideas about the demand for money, that is the demand for money hold. Nick explains it very well.

  • Bill le Breton 24th Aug '16 - 9:10am

    Hugh, I’ll try to answer. When the Gov finances a tax cut of £20 b it immediately increases the money supply by £20b. How does it ‘finance’ this? Does it sell £20 b gilts? If so, the purchase of these gilts destroys £20b. It ‘sterilises’ the effect of the tax cut. If it does not sell £20b gilts (monetary financing of the deficit – or part of the deficit) the money supply has increased, until it does so.

    Monetarists believe that in the long run this extra money will lead to a corresponding rise in the price level. But in the short term it may increase investment and through that increase output.

    If people think that the effect of a £20 b increase in aggregate demand will be inflationary – that is enough to affect the behaviour of consumers and producers – because people have new expectations and anticipate what happens next. Monetarists in the 70s thought that there were lags between increases in the supply of money and changes in prices, but now monetarists believe it all happens very quickly.

    People in markets anticipate expected effects and act quickly. If there is spare capacity,output will start increasing fairly quickly – shops will fill their shelves anticipating the increased demand – firms will increase output anticipating fresh orders. Consumers will anticipate rising prices and bring forward spending decisions.

    In effect, they decide that they don’t want to hold money and they want to ‘sell it’ for an asset – not just a share – not just a new fridge – maybe they decide to do their grocery shopping today rather than tomorrow. MOney becomes like a hot potato. As soon as you get it you want to get rid of it/pass it on in exchange for something, the price of which will be higher tomorrow. Their demand for money to hold falls – the velocity of exchange increases across the economy.

    If prices are expected to fall, the reverse happens. You want to ‘sell’ assets in exchange for money. MOney will buy more tomorrow. The number of exchanges falls. People want to hold money as it will buy more things tomorrow. If people in markets think this will happen they anticipate it. There is a reward for being the first to get into cash or safe assets – like gilts. The price of safe assets increase and their rate of return falls.

  • Monetary policy was only one part of the Tory economic approach. The crushing of trade unions, the creation of a brutally competitive labour market, the closure of much of the manufacturing base and cuts to public services, all contributed to limit inflation (though tax cuts had the opposite effect). The damage to society in terms of inequality, unemployment (and under-employment) and under-providion of public services were (and is) evident to all on the progressive side of politics. Now Tories wonder why wage growth is so weak! It is ironic that progressive parties were arguing for independent central banks – a prized institution of monetarism!

  • The only sensible answer is that it has a value because Governments demand we pay our taxes in their unit of account

    No, this can’t be the case, because there are countries whose currencies are worthless even though their government demands taxes be paid in them. So whatever gives money a value, it can’t be its tax-paying ability.

  • Bill le Breton 24th Aug '16 - 10:38am

    Peter, surely bank deposits have value because people accept them as a medium of exchange. We don’t live in a barter economy. If I want to buy eggs I need cash or a bank deposit. To get cash or a bank deposit I have to sell some thing – perhaps my labour. Plus pay my taxes as you say.

    If I think my bank deposits are going to buy me less tomorrow, I’ll ‘sell’ my deposit to someone who wants that deposit in exchange for a good or a service or some other kind of asset. If I think they are going to buy more tomorrow, I’ll wait. That is basically how recessions start.

    The advantage of a Treasury or a gilt in these times is that they don’t cost much, if anything, to store and give a small return (at present) or if they have a negative interest rate they compete well with the ‘cost’ of keeping cash or gold safe. And they are easily traded and they are ‘safe’ in terms of being backed by a Government.

  • Bill le Breton 24th Aug '16 - 10:39am

    QE? I always thought that QE was a tactic used to increase the money supply without reminding politicians that they could increase the money supply by borrowing from commercial banks through monetary financing of the budget deficit.

    When I first started commenting here in 2009 I advocated that ‘government borrowing’ was not (then) a problem. To much derision!!!! What I hadn’t realised is that people didn’t know that you could increase the money supply by financing the government deficit without matched funding via tax receipts and sale of gilts.

    Had we done that (as we did regularly in the 60s and 70s) – instead of QE – what might have happened? Well QE benefited people who held securities that the Bank of England bought from them. They then had bank deposits they they could use to buy assets, which rose in value. But there wasn’t enough of a wealth effect across the country to get aggregate demand moving into the future. And because people were told it would later be reversed they were very reluctant to ‘invest’ it in less liquid assets and projects.

    Had the monetary expansion been done through increased borrowing /or /and monetary financing of the deficit, the effects would have been permanent, the spending could have been done on infrastructure with long term productivity benefits and much more of the new money would have gone to ‘ordinary’ people.

    We may still have to do that – but it will have come 10 tens years after it could have happened. 10 wasted years. I think it has already cost the country half a trillion pounds in lost output and lost life chances. And all it really has gained is a smashed Labour Party. (And a certain referendum result)

  • Robert Wootton 24th Aug '16 - 11:41am

    @Steve Trethan, “Our economy needs greater aggregate demand.” To me , this means that people need a Disposable Income so that they can afford to spend. The austerity measures imposed by the government prevents this.
    What is needed is an alternative economic operating system that produces a stable aggregate demand. I recall reading in a Saturday’s business page of the Telegraph about 8 years ago that the CEO of Tescos was paid 2000 times more than the checkout operators.
    My argument is that new forms of businesses need to be legislated into existence. These new forms of business would have a statutory maximum ratio of 20 to 1. So if a CEO was paid £3 000 000 pa, their office cleaner, traditionally a low paid/minimum wage job would be required to be paid £150 000 pa

    Tha point of my argument is this; if income inequality is lessened so that the lowest paid people in the economy have a disposable income which by my definition is income available after rent/ mortgage, council tax, heating and lighting and food costs have been paid, then aggregate demand would be stabilised.

    What this would mean for Boards of Directors is that when they decide on their rates of pay, they would be increasing (or decreasing) the pay of the whole workforce. This could be the beginning of “responsible capitalism”.

    Also Trade Unions who fight for an increase in their members wages would also be increasing the Boards pay! This could be the beginning of “Responsible Trade Unionism”.

    Some people reading this may think I am in cloud cuckoo land because such a system does not exist. It does not fit with existing economic realities. However, since our present economic reality is a manmade construct propagated by the Centre for Policy Studies and upheld by the so-called “Washington Consensus” and the World Bank”, and this system has brought about the Global Financial crisis of 2009 and the austerity aftermath and political crises in Greece, Italy, Spain and the UK, it is absolutely necessary to alter the economic reality by dual booting the UK economy with an alternative economic operating system that produces Freedom and Fairness for all.

  • Steve Trevethan 24th Aug '16 - 2:44pm

    Some might say that a £10 tax voucher and a £10 note are different in the emotional impacts they might have. Some might say that they are similar in that they are both IOUs. Indeed your £10 note says so -“I PROMISE TO PAY THE BEARER ON DEMAND THE SUM OF TEN POUNDS”
    Which brings us back to the current inextricable connections between money and debt.
    In 1971 Mr Nixon made it official that the USA had shifted from asset money to debt money, in the form of US Treasury obligations,. This inverted the previous relationships between the balance of payments and domestic monetary adjustment. Britain played by the old rules and was obliged to give up its Empire, for good and/or ill. The USA played by its new rules. Consequently, “instead of US companies and citizens being taxed or US capital markets being obliged to finance the rising federal deficit, foreign economies were obliged to buy the new Treasury bonds being issued. America’s Cold War spending thus became a tax on foreigners. It was their central banks who financed the costs of the war in Southeast Asia.” [Super Imperialism: the Origin and Fundamentals of US World Dominance: M. Hudson]
    P.S. The power of the US military is an important factor in World finance/economics.
    P.P.S As the State has paid for banking “problems” and has a “duty of care” [real and/or imagined] towards its citizens, it is reasonable for it to be directly involved in the creation, storage and distribution of its money.
    P.P.P.S . “Debt-The First 5,000 Years” by D. Graeber, is a good read too!

  • So what would be the difference between a £10 tax voucher and a £10 banknote?

    The difference would be that a £10 tax voucher would be a little less than a £10 banknote, in exactly the same way as a £10 gift certificate is worth a little less than a £10 note, and for exactly the same reason: you can buy anything with a £10 note, but a £10 tax voucher can only be used for one specific thing, just like a £10 M&S gift voucher can only be spent at M&S.

    But you haven’t answered my point: if what makes a £10 note valuable is that the UK government demands taxes be paid in them, why is a billion-dollar note from Zimbabwe utterly worthless, despite the fact that the Zimbabwean government demands taxes be paid in them?

    Why did the cruzeiro in Brazil become so valueless it had to be replaced with a totally new currency, despite the fact that the Brazillian government demanded taxes in cruzeiros?

    And those are only two examples out of dozens. I might also mention the collapse to valuelessness of the mark, despite the Weimar government still demanding it to pay taxes.

    Clearly the value of a currency must reside in something other than its use to pay taxes, or no currency that was still asked for by a government to settle taxes could become valueless — and yet exactly that has happened, time and again.

  • Money supply is such a slippery concept that it makes a poor policy tool as Thatcher discovered the hard way – and at immense cost to the UK economy.

    For one thing the Tories then, as now, were preoccupied only with the public debt whereas in fact, as Steve Trevthan points out above, most debt is private debt which she ignored. So how did that evolve in the Thatcher era?

    Answer it exploded almost from the day she was elected soaring to an unprecedented and unsustainable level by 2008. Cue the financial crisis.

    https://youtu.be/l1Gg1RGAO6k?t=968

    The most astonishing thing through all this is that the Tories have somehow managed to preserve as their USP in the public mind the notion that they understand the economy. Both labour and Lib Dems have basically conceded this point. That needs to change.

  • “Why does money have a value …?” (Comment by petermartin2001 at 9:32)

    It’s NOT the reason usually given, namely that governments demand we pay tax in it (although that is a contributory factor).

    Rather it’s because its an “emergent property” of a complex system, that is a property of the system as a whole, not of any one part of it. A parallel is the way that life is not a property of any one molecule (although some are more important than others) but of the way many molecules interact.

  • Bill le Breton 24th Aug '16 - 5:57pm

    Gordon – this is in controvertible: “the Tories have somehow managed to preserve as their USP in the public mind the notion that they understand the economy. Both Labour and Lib Dems have basically conceded this point. That needs to change.”

    But that has to be done from the basis that monetarism (or its lastest expression Market Monetarism) is both the best way to manage an economy and that it is thoroughly Liberal in its approach. .

    When Labour lost the 1979 election they had been using monetarist ideas for three or so years . Those tactics continued following Thatcher’s victory.
    The problem both Governments faced was that nominal GDP (NGDP) was increasing at growth rates well into double figures of which nearly all were increases in inflation and very little increases in output (stagflation). See here http://www.economicshelp.org/blog/2647/economics/history-of-inflation-in-uk/
    Nor were prices and incomes policies working.

    There was a good deal of talk about controlling growth in the money supply. And many targets selected such as M4 or the Exchange Rate – the most successful was targeting and bringing down the growth rate of NGDP. This was achieved at great social cost, here and in the US, but having allowed expectations of high rates of growth in NGDP to become entrenched the only way to get back to growth was by reducing growth in NGDP to single figures and getting it back to a stable increase of around 5% a year. Once this was achieved the resulting period of stability gave 2 to 3% real growth increase a year with inflation ‘anchored’ at around 2%.

    In recent years our problem has been disinflation and deflation (rather than inflation) – it has not been possible to get NGDP growth back to circa 4 or 5% pa. It has been a political and central bank choice not to get back to that level.

    (2 + 2)% or (2+ 3)% increases in nominal GDP p.a. is a very Liberal outcome . Lower or higher levels of inflation have illiberal consequences, and lower than 2% real growth each year wastes human potential and again means lost life chances.

    A Liberal policy would set a public and target for for NGDP growth of 4.5% with a commitment that undershoots and overshoots would be leveled out in the following year – bygones would never be bygones.

  • I find the easiest way to think about government debt is to start by thinking about a company. Typically it will have buildings, vehicles machinery etc. all of which appear on one side of its balance sheet as “assets”. They are matched on the other side of the balance sheet by the company’s “liabilities”, typically some mixture of debt and equity (shares).

    Now the thing about debt and equity is that they are much closer than most people appreciate, the main difference being their risk profile – that is payments on debt must usually be made more or less no matter what whereas payments on equity (called ‘dividends’) are paid only when there is a sufficient surplus. Also they can be rolled up and kept in the company if the directors so decide. Hence there are lots of intermediate forms like preference shares that are half-way houses between debt and equity.

    So much for companies but what of governments? By convention they don’t have equity only debt but it fills the same role as equity in companies. And, as in companies, it corresponds in the real world to the tangible and intangible assets, to roads, to public buildings, to public investment in education etc.

    So when the Tories plan to pay down debt they are actually attempting to liquidate the state. Hence the recessions that happen every time they really try (as opposed to pretending). I pointed this out to some Tory friends a bit ago. They got it straight away and immediately looked as sick as parrots. Very satisfying!

    Of course this doesn’t mean that governments can spend like drunken sailors. To be viable debt must be supported by assets that it enables; that ultimately comes down to a cash flow or equivalent.

    So, if a government habitually makes bad investment decisions it will soon be in trouble just as a company would be. Unfortunately that’s exactly what recent governments have done; PFI schemes for example are ridiculously expensive compared with the government-funded alternative so they make us all poorer (except for the cronies who invest) while the supporters of HS2 are in a muddle if it’s about speed (as the name and design suggest) or capacity (as they now claim). That’s a classic sign of a problem project.

  • Bill le Breton – I basically agree but there are some serious problems with a monetarist approach (of whatever flavour).

    Firstly, there are so many moving parts and they are so poorly understood and slippery that there is a huge risk that it wriggles out of the government’s grasp without anyone noticing until much damage has been done.

    Secondly, good luck with that line on the election trail! It’s just not going to fly.

    A solution to both would be to approach the problem from a business perspective (formed in the real world that people can relate to) and NOT from an economic perspective (formed inevitably in an ivory tower) that they can’t relate to and which too often isn’t cross-checked with reality.

    A friend (whose small business was in trouble at the time) was once given some excellent business advice, “Keep on doing the right things”. It took time but it worked brilliantly. That’s the lesson that we should take to government that people will understand because they know in their bones that it’s not doing the right things now.

    So how would that have helped in recent decades and with inflation in particular?

    Well for one thing we would have focussed on apprentice-type training – not with the aim of generating good stats for ministers to boast about but to make to make skills training naturally follow opportunities and to make graduates of the various schemes the aristocracy of the world’s tradesmen. That’s a wholly different approach than has ever been tried and would commands overwhelming public support.

    Then we should have demanded far more rigour in assessing government investments. That would have see off PFI among others to the immense benefit of today’s NHS and schools.

    Put together such initiatives would have increased the productive capacity of the economy and that would have borne down on inflation by basic supply and demand.

  • Bill le Breton 24th Aug '16 - 6:53pm

    Peter, we speed it up (or set a speed) when someone we really believe says ‘this is the speed I shall set and shall not waver from’.

    A thought experiment; this person with absolute authority says “I will set the speed at 5% growth each year in money terms. And if the speed exceeds this I will put up interest rates until it falls back to 5%. And if the speed falls below that I shall increase the supply of money until 5% is regained.”

    How would a firm react to this? Would it borrow to invest if it saw the speed has risen to 5% and was set to rise above this? Surely the sensible reaction would be to do nothing and wait for the speed to fall back to 5% and the price of what I was going to buy falls back to its long term position.

    And if I saw the speed falling below 5% would I sell my factory or my treasury bond or my shares in Whitbreads? That would be foolish because next month when the speed of the economy was back up to 5% my factory, my treasury bill and my shares would be worth more.

    All you need for stability in the economy is faith in the person or institution setting the speed to make good their promise and knowledge of what the speed is expect to be tomorrow – the future expected path of NGDP that the voice of authority uses to change speeds.

  • Richard Underhill 25th Aug '16 - 8:18am

    M0 was notes and coins, but presumably affected by credit cards and debit cards.
    Look at the effect of more money from TV companies into football this year.

  • Bill le Breton 25th Aug '16 - 8:40am

    Peter – you do not have to define the money supply. You have to measure changes in nominal gross domestic product or national income.

    At present these are published retrospectively – actually nominal GDP figures are collected first and from them a figure for real GDP increases is calculated.

    But if the Bank of England created a market for NGDP futures it could be used as a proxy for NGDP changes. One of the economists who has lead the way on this is Scott Sumners – here is paper he write back in 2011 http://www.adamsmith.org/blog/thinkpieces/the-case-for-ngdp-targeting-lessons-from-the-great-recession-2

    The Treasury and The Bank of England came close to adopting it in 2012. There are growing voices for its adoption by the Fed in the US.

    If you are looking at the best measure of money for predicting future changes in the nominal economy, Sumner argues for watching the level of base money in the economy (ie Notes and coins. Commercial bank deposits with the Central Bank).

  • Bill le Breton 25th Aug '16 - 8:58am

    Richard, I understand what you are saying but in the example you quote the supply of talented footballers is extremely inelastic.

    Imagine a situation in which a resources was being underutilised … for example the huge levels of cash being held by large firms in this country. If those firms could be convinced that demand for their goods and services (and for the goods, services and wages of their customers) was ‘guaranteed’ to rise each year for the foreseeable future at 5% when today it is rising by 2.5% they could a) raise their prices or b) use their cash reserves to increase output.

    If they chose a) and raised their prices, they have to worry about competition. Will their competitors raise their prices or raise their output? And because there is 5% increase in the effective spending power of consumers, will these consumers stick with the same levels of their product and spend the ‘extra’ on other firms’ goods and services?

    For 20 odd years the economy grew in nominal terms by close to 5% each year. This delivered real growth of 2.5 to 3% and inflation remained anchored at around 2%. Markets knew that, when they saw or predicted the economy heating up above that level, the Bank of England raised its policy rate and when the economy slowed (even seriously after the dot-com bust) the Bank eased monetary policy sufficiently to get the economy back to 5% nominal growth. Certain of this they were able ti make measured investment decisions, their employees knew what their future wages would be – the system was in effect self-adjusting. The Monetary Policy Committee could have met once a year!

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