Confusion about Money and Inflation (1975)

From the January 1975 issue of the Socialist Standard

Under the influence of Professor Milton Friedman and other “monetarists” it has become fashionable for politicians and economists to discuss the rise of prices in relation to what they call “the money supply”.

Thus the City Editor of the Daily Mail, 18th November 1974:

Some experts say the money supply tells us how bad inflation is going to be in the months ahead. The increase of just 1¾ per cent in the past three months looks hopeful.

And in July last Mr. Healey said:

We have the rate of increase of the money supply under control. I propose to keep it so. It is running at roughly half the rate at which it was running under the previous government.

But the rate of the rise of prices did not halve or even slacken. In spite of whatever effect subsidies and price controls may have had, the rise of prices in the eight months after Healey became Chancellor was not smaller but greater than in the previous eight months under Tory government.

It is important to recognize that the theories of the monetarists are not at all the same as the theory of Marx. Marx showed that an excess issue of inconvertible paper currency depreciates the currency and causes prices to rise, though it is not the only factor affecting prices. Essentially, what the monetarists attempt to show is that the price level is mainly determined by the size of deposits in the banks.

What the monetarists use as their guide are the official figures for “money supply”, made up of currency (notes and coin) plus bank deposits; but the currency element in the figures is so small a proportion of the whole that the changes in the amount of “money supply” from month to month are dominated not by the increase of the note issue but by the changes in bank deposits.

Actually there are two official indexes of money supply, known as M1 and M3. The first includes current account bank deposits, while the second includes also money on deposit account. (Currency constitutes only about one-third of M1 and about 14 per cent, of M3.)

One of the absurdities of monetarist theory is that M1 and M3 rarely give the same guidance, yet both are used. They hardly ever move at the same rate, and often M1 is going down while M3 is stationary or going up. One factor in this is that if depositors transfer large amounts from current to deposit accounts it reduces M1 but does not affect M3 because M3 already includes all deposits whether on current or deposit account.

Professor James Morrell of Bradford University attacked the “money supply” concept in an article in the Sunday Telegraph on 10th November 1974:

Since one measure of Britain’s stock of money showed a 1.5 per cent rise during the past 12 months (third quarter 1973 to third quarter 1974) and another showed a rise of 13.5 per cent we may well wonder if the experts know what they are talking about.

But what of the theory that bank deposits determine prices? It is a very old theory, but one that will not stand examination. Figures are available which show that deposits in the Joint Stock banks rose from £159 million in 1877 to £890 million in 1910, but the price level was rather lower in 1910 than in 1877. And between 1921 and 1931, when prices fell by 35 per cent., London Clearing Bank deposits fell by about 9 per cent, in the first five years then, rose again to the original level.

As Professor Cannan pointed out:

Prices continued to wax and wane with currencies, and to exhibit towards the variations of bank deposits . . . complete indifference.

(Modern Currency and the Regulation of its Value, 1931, p. 95)

It is a reflection on the modern economists, including Professor Morrell, that with few exceptions they are not even prepared to look at the possibility that Marx’s theory would provide the explanation for inflation that they are unable to find elsewhere.

Edgar Hardcastle