Essays in Honour of Charles Goodhart, Volume One
Edited by Paul Mizen
Chapter 1: No money, no inflation- the role of money in the economy
1. No money, no inﬂation – the role of money in the economy Mervyn King1 1. INTRODUCTION Most people think economics is the study of money. But there is a paradox in the role of money in economic policy. It is this: that as price stability has become recognised as the central objective of central banks, the attention actually paid by central banks to money has declined. It is no accident that during the ‘Great Inﬂation’ of the post-war period money, as a causal factor for inﬂation, was ignored by much of the economic establishment. In the late 1970s, the counter-revolution in economics – the idea that in the long run money affected the price level and not the level of output – returned money to centre stage in economic policy. As Milton Friedman put it, ‘inﬂation is always and everywhere a monetary phenomenon’. If inﬂation was a monetary phenomenon, then controlling the supply of money was the route to low inﬂation. Monetary aggregates became central to the conduct of monetary policy. But the passage to low inﬂation proved painful. Nor did the monetary aggregates respond kindly to the attempts by central banks to control them. As the governor of the Bank of Canada at the time, Gerald Bouey, remarked, ‘we didn’t abandon the monetary aggregates, they abandoned us’. So, as central banks became more and more focused on achieving price stability, less and less attention was paid to movements in money. Indeed, the decline of...
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