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Over long periods, the growth rates of money and national income are similar, although not identical, in all countries. As Milton Friedman argued, the key policy implication is that the rate of money growth should be kept fairly stable over time. Stable money growth will not create paradise on earth, but it ought to avoid the severe macroeconomic turmoil seen in the Great Depression. 

But maintaining stable money growth is a tall order. Bank deposits are the principal means of payment, and hence the main form of money, in a modern economy. The unfortunate truth is that bank balance sheets' management is a hit-or-miss affair. In any one period, some customers use deposits to repay loans, which destroys money, while other customers want new credit. Banks meet this demand by adding to the borrowers' deposits, creating money. The balance between these forces is volatile and difficult to predict. 

In an ideal world, when banks and their customers behave sensibly, and bank credit, the quantity of money and nominal national income chug along at about five per cent a year, monetary policy can be "boring". (This is the word Mervyn King, the Governor of the Bank of England, used to describe the conduct of policy in the dozen or so "nice" years from the mid-1990s.) But in mid-2007, one of bankers' key assumptions in the nice years — that they could finance asset growth by borrowing from other banks — was shattered. Growth rates of credit and money started to slide and, by mid-2008, the world was in recession. 

When the crisis escalated last year, policy-makers decided that mistrust in the international inter-bank market was caused by banks' lack of capital. They then committed a horrible blunder, even though their actions seemed to be justified by the logic of events. They should have tried to boost the quantity of money by expansionary open-market operations, as Friedman had always advocated in such conditions, and given banks time to rebuild capital from the retention of future profits. Instead, they insisted not just that banks restore the level of capital that had been acceptable for regulatory purposes before the crisis, but that they aim for a level of capital much higher than had previously been the norm.

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