Jeez, monetary policy simply explained at last!

It would seem that the usual Tory view is that inflation almost invariably arises from excess money creation resulting in government deficits as a consequence of excess government spending. Broadly speaking this equates to their belief in the quantity theory of money which suggests that if too much money is created it will pursue a finite supply of goods and services, inevitably increasing their prices as a result. There are, of course, numerous problems with this claim. Firstly, the deficit may arise because of insufficient taxation, and not because of excess spending. Secondly, there is no reason to think that the supply of goods and services is fixed. Whether because more money attracts more activity into the marketplace, or encourages more people to work, or incentivises increases in productivity, this claim may be false. Third, there is no reason why the excess money supply needs to come as a consequence of government activity: banks can also create money and excess private debt can have the same consequence. The theory ignores this, although eventually when full employment is reached (which is not something with which we are familiar) it is true that this theory might have some credibility. However, my caveat is appropriate: I would suggest that we really do not know what this looks like, and therefore we do not need to worry about it.

Just to pick up on one point – for yes, of course, it’s bollocks – that assertion that the quantity theory of money ignores bank creation of money. The Q theory is:

money supply × velocity of money = price level × real GDP.

The money supply meant there is the narrow money supply, or M0. Velocity money is best thought of as the multiplier effects of banks creating credit atop that base or narrow money supply.

So, recast the equation, base money times bank activity* equals prices times real GDP.

That is, the quantity theory of money is how we incorporate bank lending and money creation into out theory of inflation. You know, rather than ignoring it?

*This is rough, wrong, but useful

9 thoughts on “Jeez, monetary policy simply explained at last!”

  1. Under Attlee, several economists defined “full employment” as an unemployment rate of 2% since “frictional unemployment” (the time spent out of work while changing jobs) was reckoned to equate to 2% because there were lots of seasonal jobs – fruit pickers, holiday providers, Father Christmas, and (in those days) professional cricketers. Under SuperMac unemployment was brought below 2%. So I am familiar with full employment – Murphy’s ignorance of the world around him is no excuse for lying about it

  2. I mean, it’s like the grunting of a caveman confronted with a Quantum computer. He recognizes its a complex object but that’s about all he has to contribute. His theory that price rises only occur at the point of full employment will be news to anyone currently grappling with even the weekly shop let alone full employment. I did enjoy his post about the Bank of England’s paper on MMT which will hopefully join the likes of your comprehensive debunking of it is a theory. I also think as inflation is seen to be long term and here for the foreseeable future he will increasingly be exposed as an utter fraud responsible for them impoverishment of millions. I look forward to that denouement of events.

  3. Isn’t MMT still best understood as governments printing money to buy votes until inflation is about to cause riots, and then taxing people more until they can’t afford to buy stuff, resulting in prices deflating again?

    I mean, it’s batshit crazy, but it’s at least explicable.

  4. On the “infinite supply of resources” bit, I’ve been trying to explain that fallacy elsewhere. Once 7.7 billion people are nurses, where do you get more nurses from? We’re already seeing it happen in reality, there’s a shortage of bus drivers because they’ve been poached to be HGV drivers. There’s a shortage of care workers because they’ve been poached to be supermaket shelf stackers. There’s a shortage of teachers because they all refuse to leave their homes.

    Wasn’t he insisting that resourses were finite the other day, so needing draconian restriction of consumption?

  5. “the deficit may arise because of insufficient taxation, and not because of excess spending”: I do insist the chap has mental health problems but I also confess he’s just plain stupid.

  6. dearieme
    Technically he (xim/ zhe whatever he’s ext) is right. You can run a deficit by spending more than you tax for an indefinite period. The bond and forex markets will then tell you when that period has ended.
    Italy is an example of what happens then. They have been running a primary surplus (excluding debt interest) fo twenty years with B all to show for it.

  7. “Technically he (xim/ zhe whatever he’s ext) is right.” I did not seek to imply that he’s wrong: my point was that it’s a bloody tautology. You can’t usefully measure taxation and spending except against each other.

    In other words it’s as if he said ‘the problem today is not an excess of warmth, it’s the lack of coolth.’

  8. “Secondly, there is no reason to think that the supply of goods and services is fixed.”

    Where did this strawman originate? In what world or analysis or theory is such an assumption made, other than when you are only looking in the short term? Obviously monetary theory allows for the economy to adjust, for circumstances to change: it simply indicates what monetary policies can be used to achieve your goals. The BoE specifically assumes that it takes 18 months or so for an interest rate change to filter through the real economy, for example. So they do not seem to believe that supply is fixed

  9. It doesn’t assume that the supply of goods and services is fixed. Rather it’s a balance between goods and services vs money. If govt creates spends money that creates goods and services at average rates or above then no inflation will occur.

    All you need is governments spending money as effectively as private individuals do.
    Which is where it always buggers up.
    e.g. HS2 will cost £120bn but only creates £30bn of actual value.

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