We have a delightful example of how Richard Murphy simply doesn’t understand the basic nuts and bolts of the economics he wants to impose upon us all. Effectively, he’s rediscovering the basics of monetary theory – and thus the nuts and bolts of monetarism.
What does this all mean? It means that we are living in a world where not all pounds, dollars, euros, yen or whatever are equal. How they came into being makes a big difference to what they are and what interest rate should be used on them, and whether they should be considered as debt, or not. This is a theme of a paper I will be issuing very soon. But what that also means is that if this power to create and manage money is to be properly used – and it is essential that it is – then this has to be understood and I do not think that is the case. I know that because the world’s central banks still think they can change a single interest rate and that this will result in a transmission effect flowing through the economy to change the way in which people think and behave. But that is not true.
Well, yes, this is true. How a piece of money is created makes a difference, what it is does, we might even think that we’ve got different kinds of money going on. But this is hardly new, this is olds. This is the basis of monetarism, of monetary theory itself.
We have different types of money:
What Are Monetary Aggregates?
Money aggregates are broad categories that measure the money supply in an economy. In the United States, labels are attributed to standardized monetary aggregates:
M0: Physical paper and coin currency in circulation, plus bank reserves held by the central bank also known as the monetary base
M1: All of M0, plus traveler’s checks and demand deposits
M2: All of M1, money market shares, and savings deposits
A legacy aggregate known as M3, which further included time deposits over $100,000 and institutional funds, has not been tracked by the Federal Reserve since 2006 but is still calculated by some analysts.
At times we go one further out as well:
The M4 private sector’s (i.e. the UK private sector other than monetary financial institutions (MFIs)) holdings of:
sterling notes and coin;
sterling deposits, including certificates of deposit;
commercial paper, bonds, FRNs and other instruments of up to and including five years’ original maturity issued by UK MFIs;
claims on UK MFIs arising from repos (from December 1995);
estimated holdings of sterling bank bills;
35% of the sterling inter-MFI difference (added to OFC deposits, within wholesale M4). For further details please see the September 2011 Statistics article ‘Estimation and allocation methods within money and credit dataOpens in a new window’. Prior to September 2011, 95% of the domestic sterling interbank (now inter-MFI) difference was allocated to OFC deposits, the remaining 5% being allocated to transits. This followed a review of its causes (see page 101 of the June 1992 Economic Trends).
The sectoral distribution of holdings of CDs cannot be fully identified; errors may affect M4 itself, as well as its sectoral analysis.
So, as standard textbook stuff, we have different types of money. To collapse all that tech up above down, we’ve narrow money – M0, or central bank money plus notes and coins, then varied additions of credit balances as we expand our definitions out to wide money. Or, as we might also put it, money and credit. Which behave differently under the influences of changes in interest rates, have different effects upon inflation and so on.
Which is going to make a significant difference to Murphy’s beloved Modern Monetary Theory of course. Because if the different monies and credits have different effects upon inflation then you’ve got to be careful which you tax away in order to reduce inflation.
We also have an equation which describes this relationship: MV=PQ.
M is money, by which we mean that narrow, central bank, money. V is the velocity of circulation. Times the two together and we get the money supply, which is equal to prices times quantity in the economy. Must be – the number of things bought and or sold times their price must be equal to the amount of money. Because the amount of money, times the number of times it is used, must be equal to the value of all the transactions that are done using money.
Which is where we get to monetarism. OK, so we want to control inflation. So, which form of money do we control the quantity of? The one that matters for P is the MV, so it’s some variation of M3 to M4, around and about. Which is a multiple of M0, the multiplier being V.
That is, Murphy’s blind man’s groping around the subject of money supply has led him straight back to the original textbook descriptions of why and how the money supply matters. And all because he’s never bothered to go find out what the textbooks actually say.
And here’s the joy of getting this analysis correct. OK, so M0 has a multiplier effect. That’s V. So, if we’re worried about P then we need to reduce M0, or M. Which we do by selling those gilts and thereby reducing, directly, M0 by reversing QE.
Which is lovely, don’t you think? By recognising that we do have different forms of money we end up insisting upon what Murphy adamantly denies – that QE reversal is the manner of inflation reduction.