Salient. Official Newspaper of the Victoria University Students' Association. Vol 41 No. 21. August 28 1978
Problems in the Proposal
Problems in the Proposal
Do these arguments stand up to scrutiny?
Table 1 shows the relationship between money supply, GNP, and the velocity of circulation. It shows clearly that there has indeed been a decrease in the ratio of M1 to GNP accompanied by a corresponding increase in the velocity. However, the figures for GNP are expressed in 'current dollar' terms. If inflation is taken into account, the relationship of GNP to money supply takes on an entirely different aspect, (see Table 2)
M1 has only increased about half the speed as GNP (current) but it has actually increased considerably faster than the real output of goods and services in the economy. In that case, even without an increase in the velocity of circulation, money has been becoming relatively more plentiful over the last twenty years. To maintain a stable price level it would be necessary to increase the money supply slower, not faster, than is presently happening.
March | M1, $m | GNP $m | M1, as % of GNP | Velocity | Inflation Rate |
---|---|---|---|---|---|
1955 | 571 | 1860 | 30.7 | 3.26 | |
1960 | 665 | 2463 | 27.0 | 3.70 | |
1965 | 745 | 3530 | 21.1 | 4.74 | |
1970 | 764 | 4809 | 15.9 | 6.29 | |
1974 | 1298 | 8638 | 15.0 | 6.65 | 9.4 |
1975 | 1332 | 9452 | 14.1 | 7.10 | 11.8 |
1976 | 1596 | 10914 | 14.6 | 6.84 | 15.7 |
1977 | 1690 | 12786 | 13.2 | 7.57 | 16.0 |
Year | M1 (money supply) | GNP (current prices) | GNP (constant, 1965-66 prices) |
---|---|---|---|
1955 | 571 | 1860 | 2369 |
1974 | 1298 | 8636 | 4864 |
% increase | 227.3 | 464.3 | 184.3 |
It is also incorrect to assert that there is any definite relationship between the size of the money supply and the rate of inflation. Looking at the rates of inflation over recent years, it can be seen that in 1975-76 there was an increase in M 1 as a percentage of GNP coupled with a drop in the velocity of circulation, but rather than inflation decreasing (as SC theory would lead one to expect) it in fact jumped from page 11[unclear: 11] to 15.7%. In contrast, in 1976-77, [unclear: the] was a substantial drop in the monet[unclear: ary ase] and a corresponding increase in [unclear: the locity] but inflation only marginally [unclear: edg up.]
[unclear: T]hat is true is that a reduction in the [unclear: mo tary] base (ie. a credit squeeze) pushes [unclear: up terest] rates and does indeed increase [unclear: one ource] of inflationary pressure. How[unclear: eve] if the government chose to clamp [unclear: dov] hard on the money supply, [unclear: provoking] severe recession, general deflationary [unclear: pre] ires would outweigh the effect on in[unclear: cre] ng interest rates. Similarly, a mas[unclear: siv] timulation of the economy would [unclear: cer trinly] bring down interest rates (as [unclear: mo y] becomes more plentiful) but would [unclear: ign] the fires of demand inflation.