Monetarist fallacies of an earlier era revived

Published: July 2 2008 03:00 | Last updated: July 2 2008 03:00
From Dr Hugh Goodacre.

Sir, Philip Booth, Tim Congdon, Charles Goodhart and their co-signatories ("Bank must take more note of broad money growth", Letters, June 30) revive all the fallacies of the monetarist policies of an earlier era. These policies depended for their justification on the false assumption that one particular element of financial credit, namely money, could be disentangled from other elements and controlled by the monetary authorities in such a way as to counter inflation directly. This policy ended in a laughing stock, with monetary targets having to be redefined in step with the financial system's manoeuvres to dodge them, from M3 to M4 via "little M0", and discussions ranging all the way up to M10 and, in the US, M14.

The reality is that if commodity prices and/or real wages rise due to economic or social conditions, whether international or domestic, then financial institutions face a demand to expand credit - and thus "money" - in response to their customers' requirements to meet higher wage bills and other costs. Central banks may accommodate this by supplying the financial institutions with the necessary liquidity in an attempt to nullify the price and wage rises in real terms. The outcome is inflation.

The same applies vice versa, as seen in the fall in inflation in the mid-1980s following the oil price crash and Margaret Thatcher's defeat of the unions. In other words, changes in the supply of credit, and thus money, are "endogenous" - they represent the response of the financial sector to economic and social conditions, both domestic and international. What economic policy needs to address is these conditions themselves, not the response to them from within the financial sector which is, at best, only an indicator of what underlies these conditions.

Dr. Hugh Goodacre
Senior Lecturer, University of Westminster
Teaching Fellow, University College London

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