Does Government money supply create inflation?
Even though monetarism was quietly retired in the UK nearly 40 years ago (because it didn’t work) here we are in 2021 and every mainstream politician and economic pundit, still frames their argument for not spending for public purpose, as if it does.
Though the UK Government can create as much Sterling denominated money as it wants, whenever it wants, it can’t spend it, if what it wants to purchase is not for sale. PPE being a fine example. Hancock told us “Money is not problem” but he wasn’t able to buy the PPE, as it wasn’t available. What was available, every Government in the world was trying to buy it at the same time. Did the Govt overpay for PPE? Undoubtedly but it wasn’t the spending that caused the inflation in prices but the lack of resources. Namely, PPE.
The best teacher is always history.
When OPEC cut production and hiked the price of oil in October 1973, it immediately made oil an expensive. 70% more expensive and a scarce resource that became biddable. All Governments were trying to buy it and up went the price. UK Inflation hit 25% in 1975 but this had NOTHING to do profligate spending by the Wilson Government and everything to do with a strategic, economic resource suddenly being limited, leading to price shock and price competition. However, ever since, this has been been spun as the Labour Government’s fault.
If Government spending competes with the private sector for resources, yes it CAN push up inflation. For example:
- If the Government decided to expand council house building nationwide.
- And to achieve this, set up its own publicly owned construction company to build these houses.
- It will go head to head competing for resources with private sector house builders.
The Government can ALWAYS outbid the private sector for available resources, materials and people, however, by doing so, it is in danger of creating inflation, as the cost of these resources would go up, as each side attempted to outbid each other for finite resources. Hence, why it is sensible for the Government to use contractors for infrastructure projects, to eliminate competition for resources.
But CUTTING Government spending can ALSO create inflation…
One example never used by the ‘Government Spending Creates Inflation’ mob, is Chile. Pinochet outsourced its economic policy to ‘The Chicago Boys’ between 1973-1983. Chile cut its public spending by 27%. The result? Nearly 400% inflation, twice. Why? The cuts in spending effectively brought large sections of the economy to a halt. Once these resources were no longer available, or could be brought to bear for productive purpose, large sections of Chilean economy collapsed and it imported inflation from abroad.
Unfortunately for the Labour Government, in 1975, they inherited the inflationary bill for Heath’s ‘Dash for Growth and the ‘Barber Boom’, when it landed on the Treasury doormat whilst they were in residency. The short-lived ‘Competition and Credit Control’ policy created by the Bank of England, allowed banks and building societies to aggressively compete for business. This created the perverse situation where borrowers were able to borrow money at one bank - at a low rate of interest - and deposit it at another bank offering a higher rate of interest, than they originally borrowed at. This deregulated mortgage market, flooded the economy with credit and fuelled asset inflation, in the form of a house price boom, that fed through into inflation. The average house price, doubled between January 1970-December 1973 as did the rate of inflation. Bank lending increased from £71m to £1.33bn and the Broad Money Supply (M3) increased 72% in 3 years.
Sterling, had been held artificially high by the Gold Standard, floated, then sank following the Gold Standard’s effective collapse, after Nixon left it in 1971 and like Chile, the UK imported inflation as imports became more expensive and in 1973, the UK imported all its oil.
As there is usually a 2 year lag, the inflation bill for all this credit largesse, coincided in the double whammy arrival of the even bigger inflation bill of the oil crisis. Note that NONE of this inflation was due to Government or Public Spending but completely at the hands of the political decision to deregulate banking, the subsequent credit boom and geo-politics in the Middle East. By 1975, that inflation fed through to reach 25%, though, once oil production was restored, it quickly fell, rather reinforcing the point this was a resource originated inflation, not Government profligacy based inflation.
Now there are those who will say all this was a failure of Government…
– in the case of Barber & Lawson - yes it was. That increasing the money supply creates asset inflation - yes it can - but it conveniently (Or deliberately) misses the fundamental difference in purpose between State V Private Sector spending.
The State doesn’t spend money to make a profit. A FIAT Sovereign Currency Issuer, such as the UK, has no use for its own money. It can create as much as wants, whenever it wants, with the above caveats in the beginning of this article. When the state builds a motorway it is built to achieve a public policy or societal purpose. The asset, the motorway, may well have a nominal value in £s and these will turn up in National Accounts but it is not going to be sold and any asset inflation is moot. The resources to build that motorway have been dispersed, or are literally trapped in the concrete.
What about privatisation, you cry? Yes, these assets were eventually sold but their ORIGINAL purpose at the point of Nationalisation, was not to be profit making. The state spends for public purpose.
The private sector will ALWAYS chase maximum profit, be it short-term profit, or profit via empire building to gain market share and crowd out the competition.
What about Quantitative Easing, I hear you cry?
After the GFC, banks stopped lending and the money supply in the UK started to shrink, a good thing you would think, considering how the Bank of England likes to proclaim how bad ‘printing money’ is for our economic well-being?
You would be wrong…
In a volte face, the Bank of England actively chose to increase the money supply by purchasing financial assets, 75% of which were Government Bonds from Pension Funds and Insurance Companies. The Bank of England paid for these purchases by creating new Central Bank Reserves, the mechanism by which banks pay each other — think LIBOR and Interbank lending and settlement. In exchange for selling the Bank of England their Government Bonds, Pension and Insurance companies would receive deposits into their banks Central Reserve Account. So, their bank would end up with a new deposit for the and a liability to Pension Fund and a new asset increasing their (the bank’s) Central Bank Reserves at the Bank of England.
According to the logic of Monetarism, all this splashing of the cash and increasing the money supply, should have been inflationary.
However, by keeping these increased reserves trapped within the Central Banking System, the new deposits went straight into the financial markets, boosting bond and stock markets to an extent they almost hit an all time high. The banks didn’t lend the new money into the real economy but used it to shore up it reserves.
So, very little of QE money benefited the real — non-financial — economy. The Bank of England estimates that the benefit to the real world, where most of us live, was 1.5–2% growth in GDP. In other words, relying on increasing the wealth of already wealthy people, in the vain hope they would go on a spending spree, harks back ‘trickle down economics. Another failed and debunked Neo-Liberal myth’ theory of wealth.
If the state chooses to charge for its services, Student Loans being a recent example, it is purely voluntary…
New Labour chose to set an arbitrary target of 50% of the population to have degrees. It chose to monetise Universities, to take advantage of globalisation and ease with which students could travel to study and to make Universities profit centres offering a proliferation of rather dubious qualifications. New Labour didn’t have to loan any student any money. It could fund Universities directly, until the cows came home. It didn’t have to make loans interest bearing. That was purely choice.
- Why does a FIAT currency issuer need to earn interest on the money only it can create?
- Why did New Labour have to expand PFIs and ask the Private Sector to build hospitals and for the privilege, be billed exorbitant amounts for their use, when it can fund the building of any hospital?
- If the Govt chooses to fund the building of HS2, to be run as an elite service for private profit, that is voluntary.
- If you use the Child Maintenance system, you now pay £20 fee for the pleasure and if you receive any payment, you lose 4% as a fee. A fee to who? G4S, of course.
Any currency issuing Government has the choice who the beneficiary of its spending should be…
To coin a phrase: “For the many not the few”. It never needs anyone else’s money denominated in its own currency to spend or to earn itself an income.