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