6 MAY 1978, Page 23


Thomas Balogh

Monetarism Tim Congdon (Centre for Policy Studies 0.75)

Nothing illustrates the swiftness of change in economic fashions (or should one say religions?) than the fact that this booklet on monetarism appears at a time when there are signs that the tremendous wave of revulsion against Keynes has broken on the rock of experience and has begun to ebb.

Now I would not deny that the Keynesians, notably those of neo-classical variety, have got it wrong. There was a snag. Inflation. It turned out to be a fatal one. Just as the neo-classical 'science' foundered on the contrast of the colossal wartime employment and output and the misery of the 1930s, on its inability to deal withthe problem of business cycles, that awkward 'unexplained residue' for which 'pure equilibrium theory . . . [cannot ] provide any explanation', the Keynesian liberals were unable to explain or deal with the general tendency to inflation which ruined Governments and threatened the structure of society. Withall progress during their dominance was more rapid than at any time and unemployment sank to unprecedented levels.

The history of economic 'science', including the century-old refusal — originating in Say's 'Law', to accept the existence of business cycles — is unedifying in any case. But the monetarist interlude stands out as an incomprehensible aberration which can only be likened to the Lysenko episode. But Lysenko had some potent persuasive arguments in the Gulag. Western economists, like Humbert Woolfe's journalists, did it unbribed and unfrightened. It is not difficult to see why economists as well as trade unionists and politicians embraced this credo with such enthusiasm. It depersonalised the economic problem. Apart from cutting public expenditure and taxation their motto was: 'keep the money supply growing at a (low) steady rate and all will be well.' What more comfort could be derived from any doctrine. It absolved everyone and all of all direct responsibility.

As so much double-talk has gone on in the past of the so-called monetarist school it is essential to define exactly what is not meant by 'monetarism'. Monetarism does not mean that there is a loose connection between money and prices or that inflation manifests itself by an increase in prices and the volume of money. We live in an economy where transactionsgre conducted, and prices are therefore expressed, in terms of money (though paper money can be and, especially after wars, has been displaced by cigarettes or bully-beef as the means of exchange) so do other transactions (e.g. loans). It is therefore self-evident that prices or incomes should affect the volume or velocity of money in circulation. The problem is whether there is a stable reversible relationship between the money stock and prices which can be used for strategic purposes.

The failure of 'liberal' Keynesian policies has unfortunately not lead to any considerable further development of Keynes towards an open-ended political economy. What happened was the revivification of the exploded monetarist school based on the quantity theory of money. The monetarist view was that 'fine budgetary tuning' is, in practice at least, destabilising; and it attributed balance of payments crises to an overblown public sector borrowing requirement and the increase in money supply, both of which were the cause of instability in an otherwise stable system. According to them the necessary and sufficient condition of stability was the steady increase in the 'money supply' a little faster than the expansion of the economy increase of the productivity.

The 'new' doctrine did not give any explanation of how the changes in the volume of money would be translated into expenditure; and even their basic foundation, the quantity 'equation' MV4PT (payments made equal payments received) was fraught with unexplained methodological difficulties. As it stood it was of course no more than an identity unusable for policy advice. It was transformed into an equation by a number of unproven assumptions or rather claims about the behaviour of each of the components. Thus it was assumed that V — the velocity of circulation — was constant; that T — the volume of transactions — was determined by the real resources available arranged in a Walrasian balance subject to existing market imperfections; and that P — prices — were the passive entity reacting to changes of the active variable M — the volume of money. Unfortunately V and T could not be ascertained directly. Thus a dummy ratio of:

was substituted as an indicator. For total transactions which cannot be ascertained, also, a proxy national income or gross national product, was substituted. The use of these 'proxies', however, and indeed the figure of M itself, of the volume of money, is most questionable. Where do liquid assets end and money begin? Which of the shortterm assets should be included was arbitrary and debatable.'

And yet we have come to the point at which even the Bank of England (not to say the central banks of the United States and of Germany), fell into the Chicago trap and regards the 'supply of money' or 'money stock' as the main, if not decisive or sole criterion of monetary management. This shows a regrettable ignorance of the complexity of the monetary system. The very concept of 'money supply' is totally arbitrary and has undergone startling changes. Foreign sterling balances are excluded from the count; not so deposits created by credit operations on their basis. For certain purposes British-owned balances in foreign currencies are not counted. The main 'indicator, `M3', does not differentiate between income deposits of individuals, business deposits, both of which themselves include convenience and precautionary deposits, and savings deposits, including speculative ones. A shift towards financial institutions other than banks and assets other than deposits — e.g. building societies or the issue by banks of bonds — would diminish the fetish and allow expansion or vice versa. The vast difference between M1 (cash) and M3 (cash plus deposits) shows the importance of the choice, inasmuch as the latter includes a goodish bit of the former's velocity of circulation. The further anomaly is that T excludes all non-income transactions (house purchases, other transfers of assets, realisation of paper profits etc.) though the all definitions of money include all relevant assets belonging to the non-personal private sector. It was not shown — and is very questionable — that the motivations of giant firms can be subsumed in the national income which accrues mainly to wage and salary earnings. The true velocity of circulation or transaction is not merely much higher but also more unstable than the

income velocity, and can be a cause of fluctuations. Changes in stocks, e.g. of inert deposits, are not caught. Neither are capital gains which subsequently appear in incomes. Why a single number indicator should reflect all complicated transactions (e.g. the speculative excesses of financiers), dislocating the system, has not been disclosed.

This is the theory which Mr Congdon displays in the confidence that it will endure.

Inasmuch as he does not refer to the wide spread criticism and growing qualification both of (mainly Friedman's) empirical mat erial and of the logic behind the conclusions especially the 'crowding out' Treasury principle, or the natural rate of unemployment (which is unobservable), one must take these conclusions — as the Maharishi's fol

lowers do — as a matter of faith. And, as Maharishi acolytes succeed in being selfjustifying, monetarism, if widely believed, will have an impact on economics —only fat from propelling the economy heavenwards it will keep it subdued because an increase in demand will then cause loss of confidence and either itself force activity down or imPel the central bank to do so. It is no coincidence that the victory of Mr Congdon' pals was paralleled by mass unemployment in the 'market' economies.

Even if one takes into account the tremendous relief from responsibility which it vouchsafes, the speed of the doctrine must arouse one's astonishment if not admiration. It should be emphasised however that Mr Congdon's exposition is clearer and therefore easier to dissect than most other economic tracts on the subject.