Why Frank Field MP is talking nonsense


by Chris Dillow    
1:30 pm - December 2nd 2009

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Via Paul, I see that Frank Field has written some utter bilge. He says:

It simply isn't possible to increase the money supply by 300% and for there not to be a megadose of hyperinflation built into the system.

This is plain wrong. I assume he’s talking here about the Bank of England’s balance sheet. Its overall liabilities/assets have quadrupled since the summer of 2008.

Now, things are complicated here by a change in the data in 2006. But there is a precedent. The Bank of England’s balance sheet also exploded in 1998-99. There was no subsequent hyper-inflation.

To see why this can happen, consider how an increase in “narrow money” – the Bank’s balance sheet – would lead to inflation.  The conventional theory is that if commercial banks’ deposits at the Bank of England rise – which they have – then banks have a bigger buffer with which to meet depositors’ demands to withdraw cash. This buffer allows banks to lend more, thus increasing the broad money stock. And with more cash in the public’s hands chasing the same amount of goods, inflation ensues.

This story, though, fails for a simple reason. The money multiplier – the ratio of broad to narrow money – has slumped, as  Charles Goodhart points out. Instead of using their cash buffer at the Bank to increase lending, banks’ contribution to broad money growth has fallen to a 14-year low.

This is partly because banks are lending less, and partly because they have increased their capital base by issuing shares, which has taken money out of the public‘s hands.

In this sense, the increase in central bank money has merely offset a decrease in private sector money creation. This is not inflationary, so much as a prevention of deflation. Now, this is not a Dillowesque eccentricity. It’s the conventional view.

The latest survey (pdf) of forecasters by the Treasury show that they expect CPI inflation to stay under 2.5 per cent until 2013, whilst the gilt market’s inflation expectations are also low.

Field, then, is arguing against the crowd. But this raises a question. When the crowd say that they are concerned about immigration, Field says we should heed their concerns. But when the crowd says inflation is no problem, Field contradicts them.

Why the difference? What reason is there to believe that the crowd is right about immigration, but wrong about inflation? I can see a strong reason to believe the opposite – concern about immigration is cheap talk, whilst people are staking money and reputations on their view on inflation. So what’s the countervailing argument in Field’s favour?

Or is this another example of what I’ve said before?:

The function of representatives in representative democracy, it seems, is take all the idiocies of public opinion, and when these are insufficient, to then add some of their own.

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About the author
Chris Dillow is a regular contributor and former City economist, now an economics writer. He is also the author of The End of Politics: New Labour and the Folly of Managerialism. Also at: Stumbling and Mumbling
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Story Filed Under: Blog ,Economy ,Labour party ,Westminster


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Reader comments


1. Dave O

Chris

For my info – has the money supply increased by 300%? Surely that cannot be factually correct?

Dave

2. Luis Enrique

Dave O

the money multiplier formula they still teach in 1st year Macro is:

M = H/[c+theta(1-c)]

where theta is bank reserves and c has to do with the demand for cash on hand in the economy. The point being that H (narrow money – banknotes) can increase 300% without M (the quantity of money) going anywhere, if theta is rising. This is what Chris is describing, I think – the BoE has been pumping H but the banks have sucked it all up in reserves and M hasn’t gone anywhere.

If he was talking about M being up 300%, you’d be right to be incredulous.

3. chris

Dave – Luis is right.
The measure that has increased sharply – by 331% in the 12 months to November 25 – is banks’ deposits at the Bank of England.
However, money as more usually measured – non-banks’ deposits with banks and building societies (the M4 measure) – has risen 11% in the year to October. And most of this growth is due to financial institutions, such as banks’ subsidiaries. The bank deposits of households and non-financial firms have grown only 2.9% in the last 12 months.


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