Money growth and inflation
Allan Meltzer, a great economist, made an observation that most staffs of Central Bank, majority of working economists as well as market practitioners hardly make use of money growth for prediction of inflation and that most of them rely on theoretical relations or Phillip’s Curve. The perception that the growth of money is entirely not relevant for inflation is quite surprising. One of the ancient and most held economics propositions is the idea which suggests that persistent variations in the level of prices are directly linked with the money supply. Several economists have repeatedly observed that continuous increase in prices of goods is directly attributed to the nominal quantity of money.
This essay will major on the subject of money growth and inflation. For instance, it will analyze economic news reports like the News Release by the Bank of England which sought to establish the role played by the monetary policy regarding Inflation and Growth.
Monetary inflation is an economic terminology that refers to a sustained rise in the supply of money in an economy of any given country. It normally leads to price inflation, that is, a general increase in price levels of products. Economists generally agree that there exists a causal relationship between the demand and supply of money, as well as prices of services and goods often quantified in monetary terms. However, there is no overall consensus pertaining to the exact relationship and mechanism between monetary inflation and price inflation. There are a sophisticated system and various arguments put forward towards the issues that are involved, for instance how accurately determine monetary base, and or how other factors like money velocity impact the relationship and the most appropriate monetary policy.
Review of previous literature shows that price levels and nominal money quantity variations are closely interwoven. Although the debate has been going on for long with substantial evidence being given, there still remains some dispute between the predicted link between inflation and money. One of the possible explanations given towards this is that the said relationship holds only over periods of time which are so long thus making the relationship uninformative for policymakers and practitioners, who concern themselves with inflation in the future, say like the next five months or a year. However, the said relationship cannot be overlooked because it has been backed with substantial evidence. Economists have to make monetary policies bearing in mind this consideration.
Monetary policies have to play significant roles in enhancing economic growth and development in any economy. Spenser Dale, when addressing the Chinese Business Association and Asian Business Association of London Chamber of Commerce and industry, gave out his opinions regarding the monetary policy objectives. Particularly, Dale considered the monetary policy’s flexibility to support employment and growth and also control inflation. He also considered the possibilities of presently having scope for additional growth without creating extra price inflation. Spencer welcomed the present interest in such crucial issues and noted that the financial crisis was partly associated with the failure of the monetary policies. In many nations like the UK, monetary policies failed to activate the growth people longed to have.
Some players have often asked if the UK’s regime that targets inflation does force the MPC to emphasize too much on inflation, instead of supporting growth recovery. In tackling this, Spenser noted that from its generation the core mission of MPC was to hit a target of 2% inflation, but in a manner that it will support employment and growth. The MPS, he explained, has always done achieved that and brought recovery after the economic financial crisis aftermath.
According to his report, Consumer Price Index (CPI) has been over the set 2% target for the majority of the past five years with an over the same period, Bank Rates were cut to 0.5% all the way from 5%. He went on to explain that there had been launched a special scheme for funding entrepreneurs through lending as a way of stimulating growth in the economy through availing credit. Spencer noted that it is because of credibility that monetary policies got the flexibility for supporting the real economy.
Other people have asked if the setting of the policy of the MPC has actually not been adequately based on inflation, that the aim is a “sham”. To this, Spenser noted that the flexibility that MPC’s remit allowed is dependent on the bottlenecks that inflation has to be taken back to the set target and this is to be done in such a manner which maintains the credibility of the target. As such the target is a crucial anchor rather than a sham.
And should this credibility be lost, the challenge on supporting employment and growth will be much more tightly binding some years to come. Low inflation provides the means to sustained economic growth and thus improved standards of living. It should, therefore, be a concern of the makers of monetary policies to evaluate the implications of their actions towards the real economy- for the strengthening of employment and output growth. It is therefore enticing and seductive to argue that it is possible to have the economy grow without a significant rise in inflationary level.
However, it is not economically justifiable by the inflation behaviour about ignoring the growth of money in attempts to predict future inflation. A proportional relationship that is positive between money and price level relative to real income has been found to be consistent with the literature review from previous researchers in this subject. The relationship between money growth and inflation is evident in data that has been made available for long periods of time as well as over shorter durations for many nations.
In the United States, the divergence between money growth and price level relative to income in the early 1990s looks to be transitory in nature and it is not unusual especially when the view is made in a longer perspective. To adhere to the economic goals of fostering growth and employment through proper utilization of resources, the emphasis is made that monetary policies have to factor in the relationship between money quantity and inflation. Although some inflation is necessary for economic growth, it should consider the living standards of citizens.
Leamer, Edward E., 1985. “Vector autoregressions for causal inference?,” Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 22(1), pages 255-304, January.
Granger, C W J, 1969. “Investigating Causal Relations by Econometric Models and Cross-Spectral Methods,” Econometric a, Econometric Society, vol. 37(3), pages 424-38, July.
Stanley Fischer, 1993. “The Role of Macroeconomic Factors in Growth,” NBER Working Papers 4565, National Bureau of Economic Research, Inc.
Fischer, Stanley, 1993. “The role of macroeconomic factors in growth,” Journal of Monetary Economics, Elsevier, vol. 32(3), pages 485-512, December.
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