25th October 2010

The criticism from Simon Ward, chief economist at Henderson Global Investors, comes in the wake of a speech by King, covered by the Belfast Telegraph, in which he warned that "there is too little money in the economy". He added that "extremely subdued" growth in broad money was one of several indicators suggesting that inflation will fall below the Bank's 2% target over the medium term. 

King is not alone among policymakers in holding this view, with Ward noting that several members of the Bank's Monetary Policy Committee have also cited weak broad money supply growth as a reason for expecting inflation to fall below target over the medium term. The argument implies the need for further quantitative easing in the UK or (QE2).

'It's the velocity stupid'

Ward however argues that the rate of monetary expansion for the real economy and inflation depend on the "velocity of circulation", which he defines as current-price GDP divided by the stock of money; and representing the flow of income supported by each unit of cash.

"The claim that money growth is "too weak" assumes that velocity will be stable or decline but it has risen strongly over the last year and there are grounds for believing that this pick-up will continue," he says. 

Spend not save 

Ward, whose full analysis can be viewed here, says:  "The view that current monetary growth is "too weak" implicitly assumes that the rise in velocity will slow sharply or reverse. But it is more likely that the financial shift is still at an early stage, with many consumers and institutions yet to take on board the MPC's message – delivered most recently by Deputy Governor Bean – that monetary savers should expect to suffer a sustained depreciation of their real wealth."

He adds: "When real interest rates were last significantly negative in the 1970s, broad money velocity rose by 39% over six years, or 5.6% pa. If such an increase were repeated now, money growth of 1-2% pa would deliver a large inflation overshoot.

'Born-again monetarists' a big danger

The MPC's "born-again "monetarists" talking up QE2 are playing a dangerous game", he warns, adding: "Broad money has been rising faster recently – by 4.5% annualised in the three months to August. With banks in better shape, asset purchases could have a much larger monetary impact than in 2009, when cash injections were partly absorbed by capital issues."

"Combined with the rising trend in velocity, this suggests that QE2 on any significant scale would lead to a further acceleration of current-price GDP expansion, entrenching and possibly extending the recent inflation overshoot."

More warnings

Ward's warning were echoed earlier this week by influential think tank National Institute of Economic and Social Influential (NIESR) which urges the Bank of England to be cautious when considering further stimulus.

Ray Barrell, acting director at NIESR, is reported by The Daily Telegraph as saying: "We are in a world we don't understand with QE….it might cause growth to accelerate very rapidly indeed."

The Institute urges the BoE to hold off from pumping any more money into the economy until the waters are clear enough to make a safe decision.

More views

Edward Harrison, founder of financial site Credit Writedowns said in a recent Twitter interview with MindfulMoney that ‘the UK is closer to a double dip than any of the larger economies, including the US' and maintains that the UK recovery is fragile; as he puts it, ‘This is not Germany, exports aren't booming to help mask weak domestic demand'.  For the full ‘Twitterview' (Twitter + Interview, I know I know, best I could do. Deadlines.) see @MindfulMoney_M .

And for a fuller explanation of Harrison's views see, ‘What I didn't say on the BBC' where he explains why the austerity measures being imposed by the coalition government may be ‘reckless'.

Quick Link

The Daily Beast weighs in on Britain's austerity measures with Marshall Auerback's ‘England's recovery plan is bollocks' article.  Come on Marshall, tell us what you really think…

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