Category Archives: Market monetarism

Has monetary policy been ‘loose’ or ‘tight’ in recent years?

One of the policy responses to the economic crisis of 2008 and comparatively subdued economic recovery, was the use of monetary policy.

Central bank policy rates were slashed to the point where the European Central Bank got a reputation for monetary rectitude for having a policy rate higher higher than 0.5%. On top of this, and less conventionally, there was Quantitative Easing, in which central banks printed up new money and used it to buy assets from the financial sector.

Despite this apparent monetary activism, there are some who think that monetary policy was too ‘tight’ – that central bankers were not getting newly printed money out of the door fast enough. Many economists, probably most in fact, think that monetary policy over the period has, by complete contrast, been unprecedentedly loose, for better or worse.

Where does the truth lie? A first step would be to determine what we mean by ‘loose’ or ‘tight’ monetary policy.

I asked this question a while ago. An economist I know told me that monetary looseness could be defined as a situation where MS > MD (money supply, MS, is greater than money demand, MD). It follows from this that monetary tightness would be where MS < MD, and the sweet spot of equilibrium would be where MS = MD. This seems a good place to start.

Well, how do you know whether MS > MD? How do we know when the S of anything is > than the D for it? By a fall in its price.

So what is the price of money? It is the inverse of the price level. To clarify that bit of jargon, think of a DVD that costs £10. That is its price. The inverse of that is that £10 costs one DVD. The DVD buyer gives up £10 to get a DVD, the DVD seller gives up a DVD to get £10.

So, a fall in the price of money would mean that more money could be bought with one DVD. Lets say that the price of money falls so that now the DVD seller only has to give up half of a DVD to get £10. For the buyer, the price of the DVD has risen to £20. In other words, a fall in price of money is better known as inflation.

The same works in reverse. If a DVD seller has to give up two DVDs to get £10, the price of money has risen, in other words, then each DVD will now only cost the buyer £5. As generally understood, prices have fallen and we have deflation.

So if we see inflation we are seeing monetary looseness and if we see deflation we are seeing monetary tightness. What have we seen in recent years?

Consumer Price Indices – RPI indices: 2008 to 2015: September 2008=100

Picture1

Source: Office for National Statistics

The chart above shows a dip from the September 2008 pre-crash peak on an index of prices of 3.8% until January 2009. In the nearly six years since then, the index has risen to 23% above that trough and 19% above the pre-crash peak. This steady, but by historic standards modest, inflation, which equals a fall in the price of money, suggests a degree of monetary looseness, which equals MS > MD.

In short, by analysing money as thought it was like any other good or service, monetary policy in recent years has been loose, but not very.

Do we have easy money?

The headwaters

This week marked the fifth anniversary of the 0.5% Bank of England base rate and the Bank of England’s Quantitative Easing program which has so far seen the Bank conjure up £375 billion of new base money and spend it on British government debt. It’s difficult to imagine money being any ‘easier’.

Or is it? At his Money Illusion blog this week, Scott Sumner asked

“1.  Japan has had interest rates near zero for nearly 2 decades.  Is this easy money, despite an NGDP that is lower than in 1993?  Despite almost continual deflation?  Despite a stock market at less than one half of 1991 levels.  Despite almost continually falling house prices?  If it’s easy money, how much longer before the high inflation arrives?

2.  The US has had near zero interest rates for more than 5 years.  Is this easy money?  If so, how much longer until the high inflation arrives?  If rates stay near zero for 2 more years, and inflation stays low, will you still call it easy money?  How about 5 more years?  Ten more years?  Twenty? (Sumner 2014)

It is a key tenet of Market Monetarist thought that a low base rate or Fed funds rate is no indicator of whether money is ‘easy’ or not[1]. The correct indicator, they argue, is the growth rate of nominal GDP; if it’s slumping money is too tight, if it’s roaring on it’s too loose, and if it’s ticking along at some predetermined rate all is rosy in the monetary garden. As a result of this analysis Market Monetarists like Sumner believe the Bank of England’s low base rates and vast monetary base expansion do not indicate ‘easy money’. Are they right?

Well, first we have to define what we mean by ‘easy money’. It’s a rhetorical term rather than a textbook one so here’s my definition (which, if you don’t accept it, probably scuppers the following analysis so feel to substitute your own); money is ‘easier’ the more people who want credit can get it[2].

There are two points to make. First, the choice of ‘credit’ rather than ‘money’ is deliberate. When most of us ‘borrow money’ we are, in fact, accessing credit which is some derivative of, or claim on money. Secondly, a point I’ve made previously (Phelan 2013), economy wide aggregates often tell us little of interest or use. Often more useful and interesting is to disaggregate. Instead of looking at the availability of credit to the British economy look instead at the availability of credit to different bits of it.

Looked at like this we would have to say that for most businesses and individuals in the UK, despite the tripling of the monetary base since March 2009, credit is not easily available and money cannot be said to be ‘easy’. The most recent Bank of England lending report in January noted that “The rate of decline in the stock of lending to UK businesses eased slightly in the year to November compared to 2012. The annual rate of growth in the stock of secured lending to individuals rose slightly to 0.8% in the three months to November” (Bank of England 2014) –November’s fall in business lending being the biggest in six months.

But banks certainly do have ‘easy’ money. That tripling of the monetary base, as I wrote recently (Phelan 2014), has flowed onto their balance sheets and stayed there. The money multiplier has collapsed and growth of base money, M0, has not led to growth in broader monetary aggregates such as M4, which would influence nominal GDP. The open handed stance of the Bank of England isn’t showing up as ‘easy’ money as Market Monetarists see it because ‘easy’ money for banks isn’t translating into ‘easy’ money for the rest of the economy[3].

Do we have easy money? On my definition that depends on who ‘we’ is. Banks face little constraint on their ability to access credit from the Bank of England so for them the answer is yes. The rest of us who rely on those banks find it rather tighter.

References

Bank of England. 2014. “Trends in Lending” January.

Friedman, Milton. 1998. http://www.hoover.org/publications/hoover-digest/article/6549

Phelan, John. 2013. “Output gaps and heterogeneity.” Accessed March 6th.

http://www.cobdencentre.org/2013/11/output-gaps-and-heterogeneity/

Phelan, John. 2014. “Britain’s inflationary outlook.” Accessed March 6th.

http://www.cobdencentre.org/2014/01/britains-inflationary-outlook/

Sumner, Scott. 2010. “Milton Friedman vs. the conservatives” Money Illusion, August 24th.

http://www.themoneyillusion.com/?p=6564

Sumner, Scott. 2014. “How much longer?” Money Illusion, March 3rd.

http://www.themoneyillusion.com/?p=26274


[1] Sumner (2010), for example, draws on Friedman’s analysis of Japan in the 1990s (Friedman 1998)

[2] For fans of mathematical notation, if E is monetary ease and C is availability of credit then E=f(C)

[3] If we think of a river, with M0 pouring out of the spring at Threadneedle Street and the broad delta downriver being M4, banks’ demand for money has built a big dam stopping the river flowing. The Market Monetarist solution to this is to get the spring pouring out enough money that it flows over the top of this dam – in Quantity Theory notation to offset the decline in V stemming from banks’ increased money demand (which with downwardly sticky P would pull down y) with sufficient expansion of M