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 latest criticism is that Quantitative Easing has been ‘good for the rich’, but ‘bad for investment’. Even the financial advice pages of the broadsheet press seem to be going down this route, which is bizarre given that the readers are mostly rich and ought to appreciate a policy allegedly in their interests. (In the note below I quote some remarks by Merryn Somerset Webb in a 12th October article in the Financial Times.) The truth is that profits are more volatile than national income, while the equity market (which is ultimately only a capitalization of profit streams) is more volatile than profits. The large fluctuations in equity prices are partly down to changing sentiment, but also critical are wide swings in the rate of growth of the quantity of money, particularly in the money holdings of the financial institutions which specialize in asset selection. (See, for example, my 2005 study for the Institute of Economic Affairs on Money and Asset Prices in Boom and Bust for an analysis.) In the short run (i.e., in the course of one business cycle) changes in asset prices are influenced by variations in the rate of money growth. So Quantitative Easing from early 2009 did help the equity market (and in that sense ‘the rich’), but it was also beneficial for demand, output and employment more widely. In the long run changes in the rate of money growth cannot affect anything much on the real side of the economy. (A caveat is that extreme inflation or deflation causes severe economic inefficiency in various ways, and that is why inflation and deflation should be avoided.) The FTSE 100 index is lower today than it was in 1999. Is Quantitative Easing (which began in earnest in March 2009) somehow to be blamed for that? Or should the policy or policy-maker supposedly responsible for the poor post-1999 performance be thanked for keeping share prices down? Indeed, does Ms. Somerset Webb think that any policy which enriches people is, by definition, wicked and evil?
Four years ago, at the worst point in the Great Recession, several leading American economic gurus said that the Fed’s easy monetary policy risked higher inflation which might imperil the recovery. In some of the early commentaries from International Monetary Research (in the spring and summer of 2009), I argued that these gurus – who included the revered Alan Greenspan and Martin Feldstein, a prominent adviser to President Reagan – were seeing ‘ghosts’. I brought together evidence from earlier recoveries to show that the typical US recovery was accompanied by the continuation of low inflation and indeed often by falling inflation. In other words, the macro news tended to be excellent during recoveries, with above-trend growth in output and profits associated with declines in inflation. This sort of macro backdrop usually saw strong gains in equity prices. Monetary policy is nearly always controversial, and the last four years have seen even more bitter and intense controversies than usual. Expansionary open market operations of a traditional kind have been labelled ‘quantitative easing’, and described as ‘unconventional’ and innovatory. Silly rants – such as those from Liam Halligan in his Sunday Telegraph column – have claimed that by its very nature QE (and regardless of the quantities and timing involved) is inflationary, redolent of ‘banana republics’, ‘the last refuge of dying empires’, etc. In fact, QE has barely failed to offset the contractive effect on money growth of tighter bank regulation and officialdom’s determination to raise banks’ capital/asset ratios. Anyhow, the latest American data show that inflation is under good control, and is in fact much lower than in 2007 and 2008. (It is not lower than in 2009 when the price level, not the level of inflation, was falling, and observers were understandably concerned about deflation)