Edited by Tim Congdon
The introduction explains why the Quantity Theory of Money is relevant to understanding the causes of the Great Recession of 2008 and 2009, just as it was relevant to understanding the causes of the USA’s Great Depression of 1929–33.
Most analyses of the Great Recession have blamed it on weaknesses of banking systems, notably excessive losses and a lack of capital. However, this mainstream approach is far from convincing, as most banks had higher capital/asset ratios ahead of the crisis than on average in recent decades. An alternative argument – that the falls in asset prices and slump in demand were due to a crash in the rate of money growth – is proposed, and is shown to be applicable to the main countries.
From late 2008 central banks pursued policies (‘quantitative easing’) which often had the deliberate objective of increasing the quantity of money, in order to mitigate the weakness in demand. The chapter reviews the debate about these policies from a traditional quantity-theory perspective. It argues that the UK’s QE was successful, in checking deflationary forces that would otherwise have led to another Great Depression.
This chapter shares a similar conceptual framework to the previous chapter, while criticizing some of its conclusions. The chapter argues that QE’s positive impact on the quantity of money in the UK was less than the size of QE operations because of ‘leakages’, while noting that changes in money’s velocity of circulation – as well as changes in the quantity of money – mattered to the cyclical path of demand and output from 2008 to 2011.
Juan E. Castañeda and Tim Congdon
At the start of the European single currency in 1999, the ECB’s intellectual framework owed much to the Bundesbank, with heavy emphasis on the role of money in the determination of macro outcomes. From 2003 this emphasis was diluted, and for a few years high money growth was associated with asset price buoyancy and incipient inflationary pressure. But from 2008 the key authorities – including the ECB – focused on ‘tidying-up the banks’, almost regardless of the consequences for the quantity of money. Extreme monetary instability in the Eurozone ‘periphery’ was one consequence.
Official reaction to the Great Recession included a sharp tightening of bank regulation, particularly of banks’ capital requirements. The chapter describes the changed arrangements as ‘the New Regulatory Wisdom’. It argues that the NRW has caused banks to limit credit and the services they provide to customers. Even if justified on microeconomic grounds (because banks are safer), the reduction in bank credit and the quantity of money had adverse macroeconomic results in the Great Recession.
The tightening of bank regulation from October 2008 included a massive increase in capital/asset ratios in the leading nations. This may have been needed to restore banks’ credit-worthiness, notably in inter-bank dealings. However, the consequent ‘deleveraging’ was one reason that a surge in the monetary base did not lead – as the textbooks envisaged – to a corresponding surge in the quantity of money, broadly defined. Monetary policy did not work as expected.