Monetarism

The changed brief of the central banks makes monetarism obsolete?

In 1923, hyperinflation in Weimar Germany [1] was caused by the central government printing money to pay for its obligations to employees and millions of striking workers in the Ruhr. The absurdity of this was (surely) obvious to all. The so-called Austrian School of economics [2] arose based on the apparently inexorable link between an increase in the quantity of money and the decrease in its value. At that level it was satisfyingly faultless, irrefragable, unassailable, for it was a priori [3].

But what is money? In the twenties and thirties the definition was relatively simple: it meant notes-and-coin. That is to say, the unlimited production of notes-and-coin soon swamped everything else. Over the subsequent decades innovations in banking have made the definition fuzzy and obscure. But obscure because fuzzy. It has become hard to define what should count as money in the context of the monetarist formula because different assets can have different roles depending on time-scales, and personal psychology. Is the money in my current account mine or the bank's? What about in my deposit account, or my 90-day account? Is an asset like a house to be included? No? But what if I sell the house and spend the proceeds? What if I merely think I could sell the house? What if I can sell the house but think I cannot? Quantitative Easing in the USA and Europe since 2008 has seen a dramatic increase in the Monetary Base (which on existing theories should have caused an even more dramatic increase in commercial activity), but there has been no sign of concomitant inflation, and surprisingly little effect on employment.

The Austrian School is in trouble. People now spend days and weeks researching and writing papers to define money in such as way that the Austrian School's formula can be shown to be valid. (This problem is thoroughly aired in reference [4].) Gone is the certainty of the a priori. A fuzzy definition brings in judgments, and fuzzy answers. If money is in short supply, it is not spent; but the reverse is not equally true; money does not have to be spent simply because it is there. Humans are as much emotional as logical.

The Austrian School is in trouble, but worse is to come. It is the duty of Central Banks to maintain: [a] maximum employment, [b] stable prices (including prevention of either inflation or deflation), and [c] moderate long-term interest rates (insofar as it is possible to reconcile those three different aims) [5]. They are not required to maintain a constant supply of money as such. Many years ago it became clear that it was necessary to release more money in mid-December when it is needed, and withdraw it again in mid-January when it is idle. Money is now created when it is needed. If you want to predict inflation, do not look at the money supply, look at inflation; for that is what the Bank of England is doing (or should be doing***). If money supply (however calculated, M₀, M₂, M₄, M_A, M_Aex, etc), is not a leading but a lagging indicator, there is no point in monitoring it. Nothing will be learned from it that could not be learned earlier by looking at the triple target of the Central Banks, viz employment, prices and interest rates. (The only gain will be for the 'Austrians' themselves if they finally find the right measure of the Money Supply; they will then be able to say they were right all along.)

(*** Of course people make mistakes. House prices in South East England are inflating steeply. So let us build lots more houses, in North East England where there is unemployment and plenty spare land. "Oh! Sorry! Now you tell me that house prices are falling in the North East. Wish you had told me earlier!")

Cawstein, Morpeth, U.K.