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Monetary Targets and the Control of the Money Supply

Published online by Cambridge University Press:  26 March 2020

David Savage
David Savage*
Affiliation:
National Institute of Economic and Social Research
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Abstract

This article discusses the experience to date with monetary targets. The first section briefly surveys the historical background to the adoption of monetary targets and gives a résumé of monetary policy during the last three years. Without delving deeply into the subtleties of the complicated art of central banking, the next section gives an inter pretation of what the Bank of England actually does when it attempts to control the money supply, which does not correspond at all closely to the simple representation of the techniques of money supply control contained in some of the standard economics textbooks. Attention is also drawn to the problems of the present approach to monetary policy making. Finally an assessment of the performance of recent policy is offered.

Type
Articles
Information
National Institute Economic Review , Volume 89 , August 1979 , pp. 44 - 52
Copyright
Copyright © 1979 National Institute of Economic and Social Research

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References

Note (1) page 44 For an analysis in the context of the textbook IS-LM model see William Poole, ‘Optimal Choice of Monetary Policy Instruments in a Simple Stochastic Macro Model,’ Quarterly Journal of Economics, vol. 84 (May 1970), pp. 197- 216.

Note (1) page 45 For an account of monetary policy up to 1974, see J. H. B. Tew, ‘Monetary Policy’, in F. T. Blackaby (ed), British Economic Policy, 1960-74, (Cambridge University Press, 1978).

Note (1) page 46 The monetary base, or ‘high powered money’, is con ceptually the total of assets which are, or could be potentially, employed as cash reserves by the banking system. It is an imprecise concept and exact definitions vary, but it is normally taken to include the banks' existing cash reserves and notes and coin in circulation with the general public. Ignoring the necessary statistical qualifications, the money supply is equal to the sum of currency in circulation and bank deposits so that, if banks maintain a fairly stable ratio of cash to deposits, an increase in banks' cash reserves must be ac companied by a multiple expansion in the money supply.

Note (1) page 47 M. Parkin, ‘A comparison of alternative techniques of monetary control under rational expectations’, The Manchester School, September 1978.

Note (1) page 48 This is a personal interpretation of Bank of England procedures and is not based on any ‘inside’ knowledge.

Note (2) page 48 Evidence by the Committee of London Clearing Bankers to the Committee to Review the Functioning of Financial Institutions, page 273, table 54.

Note (1) page 49 Some observers, usually economists in the City, have gone so far as to suggest that the movement of the money supply is in fact so closely linked with the public sector borrowing requirement that a target for the borrowing require ment is the only way to achieve a monetary target. This is to deny that the quantity of money can be significantly influenced by the actions of the central bank and that a distinction can be made between monetary and fiscal policy. In fact, both the proportion of public sector borrowing financed outside the banking system and bank lending to the private sector vary very considerably from year to year, and the fit between the change in the money supply and the public sector borrowing require ment is not very close. A regression over the calendar years 1963-1978 gives:

The coefficient of determination is quite low; less than half of the variance in the change in the money supply over the period is accounted for statistically by the public sector borrowing requirement.

Note (2) page 49 Jacques Melitz and Henn Sterdyniak, ‘An Econometric Study of the British Monetary System’, a paper presented at the Money Study Group Oxford Conference, September 1978, and T. F. Cripps, M. J. Fetherstone and W. A. H. Godley, ‘Simulations with the CEPG model’, in ‘Demand Management in Britain’ ed. Michael Posner, National Institute Economic Policy Papers I, Heinemann Educational Books, 1978.

Note (3) page 49 This result seems to be inconsistent with standard portfolio theory, according to which the elasticities of the demand for wholesale deposits with respect to the own rate and the competitive rate should be identical. Because the non-interest-bearing component of the money supply is negatively related to the competitive rate, then if all rates rise in proportion, the demand for money should, in theory, be reduced.

Note (4) page 49 Ceteris paribus, overseas investment in the public and banking sectors does not directly increase the bank deposits of United Kingdom residents, and hence the money supply, while investment in the private sector does. In fact, there is not a very close correspondence between the ‘external and foreign currency finance’ component of the money supply and the change in reserves (official financing). For example, about one half of the massive £71/2 billion of official financing in 1977 is accounted for by foreigners' investment in public sector securities and UK bank deposits, and UK banks switching into sterling, which did not contribute directly to the money supply.

Note (1) page 50 For an interesting survey of international experience with monetary targets see M. D. K. W. Foot, ‘Monetary Targets: their nature and record in the major economies’, paper pre sented at the City University Conference on Monetary Targets, 9-10 May 1979.

Note (2) page 50 At least according to the latest statistics. The first estimates suggested an increase in sterling M3 of only 7.2 per cent (at a seasonally adjusted annual rate).

Note (3) page 50 Particular emphasis is given to the beneficial effects of monetary targets on the stability of the financial system in the Mais lecture, ‘Reflections on the conduct of monetary policy, given by the Governor of the Bank of England on 9 February 1978.

Note (1) page 51 The partial correlation coefficient between seasonally adjusted percentage changes in M1 and Sterling M3 over the period 1972 to 1978 is 0.02.

Note (2) page 51 The purpose of this article has been to examine the objectives and techniques of the present approach to monetary management, without attempting the formidable task of reviewing the numerous proposals which have been put forward with a view to improving short-term control over the money supply. For an illuminating discussion of the con troversial question of monetary base control, see the Bank of England Quarterly Bulletin, June 1979.