Although Sir Mervyn King has little more than six months left of his second term as Governor of the Bank of England, his intellectual evolution continues. His latest speech, given on October 23 in Cardiff to the South Wales Chamber of Commerce, contained an intriguing sentence: “The role of the Bank of England is to create the right amount of money, neither too much, nor too little, to support sustainable growth at the target rate of inflation.”
He arrived at this conclusion after some remarks about “insufficient” and “excessive” money creation. The trouble with insufficient money creation is that it might result in “a contraction in the money supply and a depression”, as had been seen in the US in the 1930s. On the other hand, “excessive money creation leads to accelerating inflation and ultimately the collapse of the currency”. These remarks are banal in themselves as similar sentiments have been uttered by dozens of economists at one time or another. However, coming from King after a 20-year stint at Britain’s central bank they are significant, perhaps even of great significance.
First, King is clearly saying here that changes in the quantity of money “lead to” changes in macroeconomic outcomes. The assertion that money “causes” deflation or inflation is more or less explicit. This is in line with standard monetary theory, but sharply at variance with the widely-held but pervasive misconception among Britain’s academic economists that expenditure is determined by “animal spirits” and fiscal policy, and that money and banking can be ignored.
Secondly, the management of the quantity of money is said to be “the role of the Bank of England”. This agrees with numerous statements made by the British government and the Bank of England at the dawn of Thatcherism in the late 1970s and early 1980s. In those statements, as in King’s latest speech, the task of keeping money on track was seen as a responsibility of the state. The state had that responsibility, even though the quantity of money is dominated nowadays by bank deposits, which are liabilities of privately owned organisations. (Well, privately owned unless they have been nationalised or semi-nationalised.)
Thirdly, the observation that money can be “too much” or “too little” implies that there is an ideal middle figure, and that in its monetary management the Bank of England—or indeed any central bank—should conduct its operations in order to deliver that figure. Given that a nation’s ability to produce goods and services ought to be rising over time (although it may not be doing so very much in the UK at present), the ideal figure for the quantity of money ought also to be rising over time. There is a hint, in other words, about the benefits of a policy rule in which the quantity of money is targeted by the state to grow in line with productive capacity. All being well, that should keep the price level stable or, at any rate, maintain inflation at a low rate.
Am I suggesting that King’s 20 years at the Bank of England have persuaded him of the essential truths of “monetarism”, as that very ambiguous term is commonly used in Britain? Yes, that is exactly what I am suggesting. Nevertheless, King did not draw the logical conclusion from his comments on “too much” and “too little” money, and openly bless a monetary target. That of course would have been much too radical.
King’s thinking has developed a great deal in his 20 years at the Bank of England. His latest speech is utterly different from the speeches he gave in the 1990s, when he was—in effect—learning on the job. (His academic specialisations were in tax and company finances, not in money and banking.) He has been educated by events as well as by books he has read, and the seminars and meetings he has attended. He has in fact arrived at a position similar to that of a large number of other people exposed to much the same set of influences over a long period of time.
But King’s attitude towards the financial sector remains as hostile and bigoted as that of most university dons. He was a leading advocate of the large-scale recapitalisation of Britain’s banks in late 2008, which was followed by a plunge in money growth and the worst six-month slump since the 1930s. (See my article “Gordon Brown’s Recessional” in the March 2011 issue of Standpoint.) He is now advocating a repeat of the exercise, apparently unaware that the inevitable consequence would be another sharp downturn in the economy. He has learned a lot in the last 20 years, but his understanding remains incomplete and unsatisfactory, and he has been the most disastrous Governor in the Bank’s history.