Debts have continued to build up over the last eight years and they have reached such levels in every part of the world that they have become a po- tent cause for mischief,” according to William White, former chief economist at the Bank for International Settlements in an interview for the Daily Telegraph on January 20. According to White, “the situation is worse than it was in 2007. Our macroeconomic ammunition to fight downturns is essentially all used up.” White’s pessimism chimes with warnings from Goldman Sachs last year. Andrew Wilson, chief executive of one of its fund management businesses, was reported on May 26, again in the Daily Telegraph, as saying that excessive debt represents “a risk to economies” and is a “major issue”. Specifically, in mature industrial nations populations are ageing and the proportion of working-age people to the total population is falling, presenting “us” with the question of how “we” are “going to pay down the huge debt burden”. The combination of the Bank for International Settlements, Goldman Sachs and the Daily Telegraph ought to be intellectually overwhelming. But they have indulged in rhetoric and used words sloppily. To whom does “us” refer? Who exactly are “we”? And, although the image of “the world drowning in debt” is often invoked, what is it supposed to mean?
Evidence from the years of the Great Recession justify renewed attention to a broadly defined concept of the quantity of money in central bank researchControversy over the use of monetary aggregates undermined the impact of the monetarist counter-revolution of the 1970s and early 1980s. Top central bankers accepted Milton Friedman's dictum "money matters" was valid in some sense, but they were unsure exactly how and why it mattered. Practical application was elusive when their research departments produced data on half-a-dozen monetary aggregates. Which concept of money was of greatest importance - or at any rate of some relevance - to the determination of macroeconomic outcomes? Anthony Harris, one of the Financial Times' leading commentators, compared the quarrel to that between the 'Big-endians' and 'Little-endians' about the best way to open a boiled egg in Jonathan Swift's Gulliver's Travels. Some economists favoured 'broad money', which included all bank deposits and occasionally even included liquid assets that had arisen outside the banking system. Others supported 'narrow money' - generally taken to mean notes and coins in circulation plus sight deposits. The majority of monetary economists did not regard the monetary base (the liabilities of the central bank) as equivalent to 'the quantity of money' based on any definition. Instead, they believed the change in the base influenced the change in narrow money and hence affected expenditure at a further remove. However, some participants in the debate thought that the monetary base by itself, regardless of its role in banks' creation of money, had a significant bearing on spending and the economy.
The following note – or rather set of notelets – is heavily based on my latest submission to the Shadow Monetary Policy Committee, a body set up by the Institute of Economic Affairs in July 1997. In my comments on the UK, I argue that recent monetary trends argue for the validity of the monetary theory of national income determination. Hence, they do not justify alarmism about the inflation outlook, although it is true that the supply-side performance of the UK economy has been poor in recent years. This has been a key reason that low growth of national output in nominal terms has been accompanied by disappointing inflation numbers. I also discuss output growth trends at the world level, to see whether similar concerns about supply-side performance apply more generally. The results came as a bit of a surprise. Of course it is well-known that growth was strong in the global boom of 2004 – 07. In fact, the global boom of 2004 – 07 was the most powerful since that of the early 1970s, which also had to be aborted as rising commodity prices were accompanied by a more general inflation problem. 2009 was the first year since the Second World War in which world output fell. However, the last decade has in fact been an outstanding one for growth. Despite the 2009 dip, the ten years to 2012 saw an average annual growth rate of output of 3.8%. That is a fantastic rate of growth by any past standards. (A 3.8% annual rise in real incomes would imply an almost 14-fold rise in a lifetime of 70 years.)
Mario Draghi became president of the European Central Bank on 1st November, 2011, at a critical moment for the euro. Banks – particularly banks in the Club Med countries (i.e., Italy, Spain, Greece) – were having difficulty rolling over their inter-bank lines. As the lines matured with little prospect of renewal, the banks were being forced to sell liquid assets. As these included bonds issued by Club Med countries, the price of the bonds fell and their yield increased. A surge in Italian and Spanish government bond yields was taken to constitute “the Eurozone sovereign debt crisis”. The media were full of talk of “a bazooka” of some sort to bring the crisis to an end. In October last year such talk usually focussed on the expansion of the European Financial Stability Facility, a back-up fund with resources provided by all Eurozone member states and able to extend credit to particularly hard-pressed governments. A widely-held view was that the EFSF might need to exceed 900b. euros, or even 2,500b. euros, if it were to have the fire-power to meet the crisis. In the event, negotiations for the EFSF have not got far enough, while its credibility in financial markets has been undermined by the credit rating agencies’ downgrading of several member states. But Draghi has found a big, powerful bazooka and aimed it with precision. Between 4th November 2011 and 20th January 2012 the ECB’s lending to banks has jumped from 580.0b. euros to 831.7b. euros, or by over 43%. The new lending has taken the form mostly of three-year facilities at 1%, which – on the face of it – are extraordinarily privileged loan arrangements for the banks. Further large expansion of such lending is to be envisaged. The banks have stopped selling government bonds, the yields on Italian and Spanish bonds have fallen, and the sovereign debt crisis is over, at least for the time being. This weekly e-mail analyses the effect of the Draghi bazooka on Eurozone M3 growth, because of the importance of money to macroeconomic outcomes more generally.
In my e-mail note of 8th April I argued that the bull market was “running on empty”. The argument was that the nominal level of equity prices could be viewed as the product of
- The quantity of money allocated to equity funds by investors, and
- ii. Equity fund managers’ desired ratio of money to their total assets (i.e., their “bullishness” or “bearishness”, or indeed their “liquidity preferences”, as Keynes would have put it).
Consumer prices in the Eurozone were static for most of 2009, but the latest annual rate of change has been affected by large increases in oil and other energy prices. The price of crude oil virtually doubled in the year to December 2009/January 2010, as the OPEC member states restored production discipline after the mayhem of late 2008. Despite the oil and energy price movements, the increase in Eurozone consumer prices (i.e., “prices in the shops”, roughly) in the year to February was only 0.9%, while in the year to January producer prices (i.e., “prices at factory gates”) were down 1.0%. Underlying inflation pressures are non-existent. In fact, over the next few months more companies plan to cut prices than to raise them. Regardless of fact, some economists are always worried about a future rise in inflation. The late Lord George, governor of the Bank of England from 1993 to 2003, famously ridiculed such people as “inflation nutters”. A recent speech given by Jurgen Stark, the ECB director responsible for economic and monetary analysis (i.e., “the ECB’s chief economist”), has to be described as a bad case of “inflation nuttiness”. Despite a reputation as an economist who believes in the macroeconomic importance of the quantity of money, the speech (given on the 16th March to the European Parliament) said almost nothing about the current collapse in Eurozone money growth. It did not draw the conclusion that the – largely because the M3 money measure has not changed in the last year – the Eurozone could face deflation in late 2010 and 2011. Many Eurozone banks are still anxious that they would be unable to fund their assets if the ECB withdrew its refinancing facilities. Stark’s message – that these facilities, which he termed “non-standard measures”, must be phased out “to avoid risks to price stability at a later stage” – must be characterised as inflation nuttiness of a high order.
Britain must produce as much food as possible," Hilary Benn, Secretary of State for the Environment, Food and Rural Affairs, told the Oxford Farming Conference in January. For Mr. Benn, who rounded off the proposition by adding "no ifs, no buts", nothing could be more obvious. Wasn't Mr. Benn uttering a mere platitude? Who would dispute that every nation must produce "as much as possible", the maximum, of everything? Well, Adam Smith, the founder of economics, would. His key argument in the Wealth of Nations, published in 1776, was that a nation had a finite quantity of resources, which were to be allocated between industries in the most efficient way. Although that may sound banal, it quickly leads to the refutation of Mr. Benn's maximization idea. In his chapter "Of restraints upon the importation from foreign countries of such goods as can be produced at home", in book IV of the Wealth of Nations, Smith conjures up the image of wine-making in Scotland. "By means of glasses, hotbeds and hot walls, very good grapes can be raised in Scotland, and very good wine too can be made of them."