Consider the role of money first. Ask non-economists, “What is economics?” and they will often reply that it is “all about money”. Yet the odd thing is that the standard academic models used by most economists ignore money altogether. Inflation instead depends simply on the amount of spare capacity in the economy.
Nor does the money supply play any role in monetary policy in most countries, notably America. Alan Greenspan's last ten speeches as chairman of the Federal Reserve contained not a single use of the word “money”.
Yet Milton Friedman's dictum that “inflation is always and everywhere a monetary phenomenon” is still borne out by the facts. The chart plots the rate of inflation and broad money-supply growth in 40 economies over the past 30 years. In the long run, countries with faster monetary growth have experienced higher inflation. So why are central banks (except the ECB) paying so little attention to money?
The problem is that over short periods the link between the money supply and inflation is fickle, because the demand for money moves unpredictably. The Bank of England's early days provide a good example. Uncertainty over exactly when ships laden with valuable commodities would arrive in London could cause unexpected shifts in the demand for money and credit. The uncertainty was caused by many factors, notably changes in the direction and the speed of the wind as ships came up the river Thames. The bank's Court Room therefore had a weather vane (still there today) to provide a surprisingly accurate prediction of shifts in the demand for money. Sadly, no such gauge exists today. Financial liberalisation and innovation have also distorted measures of money, making monetary targeting—all the rage in the early 1980s—unworkable.
http://www.economist.com/finance/displayStory.cfm?story_id=5662647
:) Falkor
Nor does the money supply play any role in monetary policy in most countries, notably America. Alan Greenspan's last ten speeches as chairman of the Federal Reserve contained not a single use of the word “money”.
Yet Milton Friedman's dictum that “inflation is always and everywhere a monetary phenomenon” is still borne out by the facts. The chart plots the rate of inflation and broad money-supply growth in 40 economies over the past 30 years. In the long run, countries with faster monetary growth have experienced higher inflation. So why are central banks (except the ECB) paying so little attention to money?
The problem is that over short periods the link between the money supply and inflation is fickle, because the demand for money moves unpredictably. The Bank of England's early days provide a good example. Uncertainty over exactly when ships laden with valuable commodities would arrive in London could cause unexpected shifts in the demand for money and credit. The uncertainty was caused by many factors, notably changes in the direction and the speed of the wind as ships came up the river Thames. The bank's Court Room therefore had a weather vane (still there today) to provide a surprisingly accurate prediction of shifts in the demand for money. Sadly, no such gauge exists today. Financial liberalisation and innovation have also distorted measures of money, making monetary targeting—all the rage in the early 1980s—unworkable.
http://www.economist.com/finance/displayStory.cfm?story_id=5662647
:) Falkor
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