If only Ritchie understood Friedman

Or even money itself:

The UK is expected to have GDP of £2,054 bn this year (table 4.1 here).

In current cash terms that is expected to grow to £2,116 bn the following year. That is a nominal increase of 3%. 1.5% of that is real growth. The rest is forecast by the Office for Budget Responsibility to be the result of inflation.

In April this year M4, which is the broad measure of UK money supply, was £2,356 billion. That M4 is greater then GDP is normal. It had risen by £45 billion over the previous year.

I make the point for a reason. That reason is to note that we need new money creation each year. Money can only be created in two ways. Banks can lend it. Or the government can create it by running deficits.

Right now the government is aiming for and achieving a current fiscal balance: it is balancing its books on day to day spending. It is borrowing for investment, but not to cover current spending.

The aim of Chancellors for almost a decade now has been to reduce borrowing to zero: in other words, to withdraw from new money creation.

That means the private sector has to go increasingly into debt to fund the creation of the new money the economy needs. The risk of a private debt crisis is increasing as a consequence.

That a growing economy requires more money is quite right. Milton Friedman said so thus it is true. And wouldn’t the Senior Lecturer be pissed to know that he’s following in St Milt’s footsteps?

However, as ever, the Great Tuber is missing some basic education in the subject under discussion. There is the interaction between base money and wide. That V in MV = PQ thing. We know very well that V is significantly depressed. That’s why the vast slugs of QE cash creation have only limited deflation, not caused galloping inflation. Which, as a matter of mathematical necessity, they would have done if V hadn’t fallen.

And as V recovers – which is just the same thing as saying the economy does and thus we raise interest rates again to temper that V – then we need less of that government created money to increase the wider money supply, don’t we?

19 comments on “If only Ritchie understood Friedman

  1. It’s help if Murphy understood money, let alone Friedman. And by money I do mean the money people use, not the government created funny money it creates to get its sums right.
    Money is a reflection of the goods & services in an economy. One can forget assets, apart from newly created assets, because in a transaction involving assets the money used to buy the asset is now in the possession of the seller of the asset. Net zero effect on total money needed. So if you want to keep the value of money constant against the value of those goods & services. Or gently & predictably falling – inflation (why you’d want to do that I haven’t the vaguest). The money supply needs to balance the availability of goods & services. Because exchanging those is the sole purpose of money. Nothing else.
    Anything else is bollox.
    People use that government designated & generally fucked about with money because it’s marginally convenient. Solely that. Stop being convenient & they’ll use something else. Goods & services will still be exchanged.

    Sometimes I think it helps NOT to be an economist & use some common sense instead. Economists are not required for an economy to function. Particularly pretend ones at London schools for the intellectually challenged.

  2. “If only Ritchie understood Friedman”

    I imagine the parents of Murphy, the former Mesdames Murphy and former colleagues and friends of Murphy said

    “If only Ritchie…….” [followed by a resigned sigh]

    rather regularly

  3. If the private sector is creating more debt, and the public sector less (as the public sector tries better to balance its books), it suggests that comparatively more activity is taking place in the private sector and less in the public.

    Which is “a very good thing indeed”.

    Because the public sector is on average far less efficient than the private sector. One can hope, but it could even mean fewer public sector diversity officers and more private sector plumbers (or whatever your flavour?)…

  4. This whole ‘velocity of money’ thing is bollocks. Its just a construct to explain something we don’t understand.

    ‘Why hasn’t all the extra money printing created inflation?’

    ‘Because V has fallen of course!’

    ”Why has V fallen?’

    ‘Because prices haven’t gone up despite all the money printing, silly!’

    V is just a variable factor to make the equation work. Its not something that exists in and of itself, you can’t go out into the economy and measure V, ergo it can’t be causing anything else to change.

  5. It’s possible to measure V directly. In a pure cash economy, it’s how many times a note changes hands each year (or whatever time period you’re looking at).

  6. “Money is a reflection of the goods & services in an economy.”

    It’s a measure of the trades currently in progress.

    You want to exchange goods/services of value to you for goods/services of value to other people. But you can’t always find somebody who wants what you’ve got and has got what you want, and not always at the same time. So you split the trade into two – first what they want for money, then later money for what you want. Money is a measure of the uncompleted transactions in progress. It is a measure of the good you have done to society that society has not yet repaid.

    “Or gently & predictably falling – inflation (why you’d want to do that I haven’t the vaguest).”

    Because people generally value stuff now more than stuff later, and if the value of money is not dropping at roughly that same rate people will either hoard it or try to get rid of it, and it ceases to be so useful as a medium of exchange. Instead of thinking about the goods/services you’re using money to exchange, you’re thinking about how much you’re losing because of inflation/deflation. It distorts the markets, giving a suboptimal allocation of resources.

    “This whole ‘velocity of money’ thing is bollocks. Its just a construct to explain something we don’t understand.”

    We *do* understand it – it’s a case of “stating the bleedin’ obvious”. If £100bn of transactions in total occur over a year, but only £1bn are in progress at any one time, then obviously each unit of exchange must have been used on average 100 times. Unless you think the laws of arithmetic don’t apply in finance/accountancy?

    It’s just a matter of how frequently transactions occur; how long people hang on to money they get before spending it again. If someone was able to monitor every single transaction (like in a totally cash-free bank-mediated digital economy), it would be directly observable.

    It’s true we don’t fully understand everything about what makes it go up and down, but we certainly know what it is.

  7. “This whole ‘velocity of money’ thing is bollocks”

    Not really Jim. The original definition was as a count of the number of transactions in a period of time that an amount of money could create or support. That is, if a pound was issued at end Q1, how many people would have used it to buy Mars bars by the end of Q2? It’s a measure of liquidity.

    Tho’ Chris and NiV beat me to it.

  8. What Jim said. That equation is just a pointless truism. And as Mises explained you don’t need to increase the money supply as production increases.

  9. What Jim said. That equation is just a pointless truism. And as Mises explained you don’t need to increase the money supply as production increases.

  10. “What Jim said. That equation is just a pointless truism.”

    *Every* statement in mathematics is a pointless truism, from a certain point of view.

    “And as Mises explained you don’t need to increase the money supply as production increases.”

    M = QP/V, so as long as P/V decreases faster than Q increases, yes.

    Decreasing prices, or increasing velocity?

  11. Don’t forget the capital side of the economy, house prices and stocks have been the recipients of some of the QE leading to quite large increases in house prices since 2008.

  12. One is reminded of the old joke about a Cambridge maths professor beginning a lecture by writing out a lengthy equation. “Well, gentlemen*, I think we can agree that this is obviously true.” He then turns back to the blackboard and stands still for five minutes, and then silently walks out of the lecture theatre. 15 minutes later, he returns: “Yes, I was right, it is obvious.”

    * I told you it was an old joke

  13. Velocity of money may have meant something in a largely cash economy, by definition a pound note hidden under a mattress wasn’t doing anything just sat there, so the more times it changed hands the better. In a 99% electronic money world its meaningless.

    If its so obviously real, how come we don’t have monthly figures for V published, like we do for money supply and inflation, GDP etc etc? Why isn’t it one of the major economic stats?

    Because its unmeasurable of course. But everyone ‘knows’ MV=PQ. Why? Because all the text books say so……the whole thing is a totally circular argument.

  14. MV=PQ is a mathematical identity, following from the definition of those letters, and explained in the early pages of most economic textbooks. It is only wrong if you believe 2+2 does not equal 4.

  15. “We can count clicks on bank accounts’

    Where’s the stats then? I can look up all the other economic stats, where’s the velocity of money ones?

  16. “MV=PQ is a mathematical identity, following from the definition of those letters, and explained in the early pages of most economic textbooks. It is only wrong if you believe 2+2 does not equal 4.”

    I can make any number equal any other number if I add in a mysterious other multiplier that varies how I say it will vary with no empirical data as to its size.

  17. [Rolls eyes]

    Of course there’s empirical data for it – you can use the formula itself to work it out.

    According to their annual accounts, Airport Taxis Ltd took 200 people to the airport last year at £10 a trip (from their revenue statement). They have 20 taxis (according to their capital assets). So each taxi took (on average) £100. It can be no other way.

    (Number of taxis = 20)x(Takings per taxi = £100) = (Number of trips = 200)x(Price per trip = £10)

    (Money supply)x(Velocity of money) = (Quantity produced)x(Price)

    Pointing out that the accounts don’t record how many customers each individual taxi driver took, so we have no way of knowing what the average was, doesn’t fly. We know from the totals what the average would have been if we’d been able to record them all.

    The maths is trivial. It was only of interest because nobody had explicitly thought – in the macroeconomic analogy – about the company revenue in terms of ‘takings per taxi’, or how changes in efficiency of individual taxis could affect the bottom line.

  18. “Of course there’s empirical data for it – you can use the formula itself to work it out.”

    LOL. And therein lies my point……….its totally circular.

    Measure the velocity of money by examining whats going on in the real world, and then see if the equation works……

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