Monetarism revisited

Goodhart’s law states that once you start targeting a certain statistic in the course of economic policy, the relationship between that statistic and the economy breaks down. Charles Goodhart was a Bank of England advisor, and the law gained publicity during the 1980s attempts by the Conservative government to target the monetary aggregates (broad money (M4 – money in bank accounts and circulation), and narrow money (M0 – notes and coins and money in circulation)) as a method of controlling the UK’s inflation problem. Whilst targeting the amount of money flowing around the economy has become unfashionable over the past decade – partly because inflation was falling steadily even though the money supply stayed strong – there are signs that monetarism might again have its time in the sun.

The statement accompanying last week’s Bank of England rate hike highlighted the fact that “credit and broad money growth remains rapid”. And the European Central Bank is stressing that even with core inflation there below its 2% target, rates will still rise because of the strength of the M3 measure of monetary growth. It looks like the only dissenter is the US Federal Reserve. Ben Bernanke, the Fed Chairman, suggested that it would be “unwise in a US context” to place too much emphasis on these statistics, going on to say that “the rapid pace of financial innovation in the US has been an important reason for the instability of the relationships between monetary aggregates and other macroeconomic variables”. In other words, the ever changing nature of “moneyness” means that setting interest rates purely on the basis of monetary statistics would be a mistake. But the fact that we’re having the debate again, at a time when money supply growth is so strong, makes me suspect that global rates go up again, before they can come down.