Does the stock of money have any causal significance? 71 changes suggested above if money is to be firmly reinstated within the confines of this model.
The argument could be put forward that Laidler’s (1999) notion of active money would fit in with the approach of Bernanke and Gertler (1999) in the following sense. What Laidler (1999) would identify as active money, Bernanke and Gertler (1999) would think of as liquidity that removes credit constraints.
It also seems to be the case that in both approaches it is entirely ignored that there are two sides to the balance sheet, so that, when the stock of money is high, the stock of loans outstanding is also high, in that at least collectively people have taken out loans that would enable them to spend. It might also mean that, when the stock of money is high, there are credit limits (as the stock of loans is high). It might also mean that, when the stock of money is high, the stock of loans is also high, but still credit limits prevail.
changes in the stock of bank deposits. The recent developments on monetary policy, some of which have been summarized in this study, deal with money as if it were endogenous, but without labelling it as such and, more seriously, without providing relevant theoretical arguments for the endogeneity of money.
We would suggest that a fruitful way forward is to develop theoretical arguments on the premise of endogenous money, and to study the process of credit creation (and thereby the creation of bank deposits) rather than just model the stock of money as a residual. This would also have to analyse the credit system, and explain how the demand for loans is (or is not) satisfied by the banks. Such an approach would be more fruitful and would, indeed, provide a more promising attempt to deal with monetary phenomena.
NOTES
1. We prefer to use the term ‘stock of money’, rather than ‘money supply’, here in that the term supply of money implies that the amount of money is determined by the suppliers of money. In this context, the argument is that equation (5.1) is based on a demand for money approach, with the added assumption that the stock of money is determined by the demand for money.
2. If stock of money is interpreted as M1 (or a broader definition of money), then this should be interpreted as the amount of money which the central bank would have to ensure that the banks provide.
3. There are other theoretical arguments for the inclusion of [mt – E(mt+1)] in equation (2.1′), in addition to transaction costs emphasized in McCallum (2001). These arguments are summarized in Leahy (2001, pp. 161–2), and include non-separable utility, utility con- straints, cash-in-advance constraints, segmentation of the goods and assets markets, and the lending view.
4. There is a sharp distinction between endogeneity and exogeneity on the one hand and passive and active views on money on the other hand. The passive and active views on money are actually based on the proposition that money is endogenous in any case. Laidler (1999, section 3) is very explicit on the importance and precise distinction of these notions.
5. These shocks range from economy-wide to localized shocks, foreseen and unforeseen, as well as transitory and permanent. The analysis in the text assumes permanent shocks;
transitory shocks are unlikely to have any significant effects in that, by their very nature, it is expected that they are quickly reversed. Brunner and Meltzer (1993) argue for the relative importance of the transitory versus permanent shocks distinction, in relation to that between economy-wide and localized shocks.
6. This is certainly the case for the models of the Bank of England, the European Central Bank and the Federal Reserve System.
7. For discussion of endogenous money approach see Cottrell (1994) and Howells (1995); for the implications for monetary policy see Chapter 7 below.
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6. The inflationary process
1 INTRODUCTION
It can be readily seen from our previous discussion of the NCM (especially Chapter 2) that the view of inflation within the NCM is one of ‘demand pull’
only. The simple model used in Chapter 2 drew heavily on the reduced form of the Phillips curve in which price inflation was linked to output (relative to trend) and expected inflation, and hence with demand. In this chapter we outline what we see as a more suitable framework for the analysis of the
‘inflationary process’. In our perspective on inflation, demand and changes in demand have a role to play, but there are other important ingredients, notably the role of cost and distributional pressures, imported inflation, the size of productive capacity and endogenous money. These other ingredients are of equal, if not of greater, importance in our understanding of the ‘inflationary process’.
Another important ingredient of the NCM approach is the assertion of a supply-side equilibrium level of output (or, equivalently, employment) which is unaffected by the path of the economy. This may be seen by reference to equation (2.2) in Chapter 2, where a zero output gap corresponds to this supply-side equilibrium. This generates the significant conclusion that defla- tionary policies (whether designed to reduce inflation or used for other purposes) do not have any long-lasting impact on the level (or growth) of output.
The nature of the supply-side equilibrium is also of considerable relevance for economic performance and economic policy. The question may be posed as to what are the factors which determine the supply-side equilibrium, and specifically what factors determine the volume of employment associated with that supply-side equilibrium. It is not readily apparent in the ‘stripped down’
version of the NCM approach presented in Chapter 2 that the labour market is seen as playing the key role in the determination of the supply-side equilib- rium. A relationship such as equation (2.2) (see Chapter 2) is often referred to as the Phillips curve, and the origin of the Phillips curve was a ‘trade-off’
between wage changes and unemployment. The rate of unemployment at which real wages would be constant (and hence wage inflation equal to expected price inflation) has often, following Friedman (1968), been labelled the ‘natural rate
of unemployment’. In Friedman’s original paper, and in much subsequent work, the determinants of the ‘natural rate of unemployment’ are seen to relate to the labour market. These have been given a number of meanings, ranging from the form and extent of trade union power and influence, to the setting of minimum wages, and to the operation of unemployment benefits and so on.
Thus the view has been formed that the supply-side equilibrium depends on the labour market, and that measures to make the labour market more ‘flexible’, and thus less ‘regulated’, will lower the ‘equilibrium’ rate of unemployment.
In this chapter we present a rather different analysis of the macro economy;
it is one that we utilize in the chapters that follow. The significant implica- tions which we draw out of our analysis are the following:
● the pace of inflation cannot be associated with a single factor (such as demand) but rather arises from interactions between a range of factors:
in our analysis this range of factors includes the level of productive capacity, the struggle over income shares, the level and rate of change of output and the international inflationary environment;
● what may be viewed as a supply-side equilibrium position, that is one consistent with a constant rate of inflation, depends on the scale of the capital stock (and therefore productive capacity) and hence is con- stantly changing as investment occurs, changing the capital stock;
● there are no strong market forces which push the economy towards that
‘equilibrium position’.
We begin this chapter by elaborating on the key elements of this structural- ist view of inflation, supplemented by an investment relationship that completes the picture. An attempt to draw out the implications of the structuralist analysis to the inflationary process is then provided. This is followed by a discussion of a number of empirical questions, before we conclude this chapter.