The text of the letter follows:
In a letter to the Financial Times in September 2006 we warned that rapid growth in the quantity of money would lead to higher inflation. Our fears have been vindicated. We welcome Governor Kings recognition in his recent letter to the chancellor of the exchequer, that a fall in the growth rate of broad money is relevant to future inflationary pressures.
However, there was little else in the letter to suggest that mistakes would not be made in the future as a result of ignoring information in monetary statistics.
Indeed, Mr King placed the blame for the increase in inflation entirely on the rise in commodity prices and the fall in the value of sterling, as if these were outside UK policymakers control. Loose monetary policy throughout much of the world must surely be responsible for part of the rise in commodity prices, just as it was in the period 1972-74.
It is of course true that UK policymakers cannot control either monetary policy in other countries or commodity prices in foreign currency terms. However, rapid growth of the quantity of money often leads to currency depreciation. Tighter monetary policy in late 2006 and early 2007, the need for which was clearly signalled by fast money growth and high asset price inflation, would have led to a stronger pound over the past 18 months. That would have reduced the impact of rising international commodity prices on the UK price level.
Early signs of a sharp deceleration in money growth are now emerging, particularly when adjustments are made for involuntary balance-sheet expansion of some financial entities which may have limited relevance for the wider economy.
Monetary data are always difficult to interpret and the present situation is no exception. However, it is essential that the monetary policy committee take more note of the growth of the quantity of money to avoid policy mistakes in the future. The latest cyclical episode has demonstrated, yet again, the relevance of money and credit to demand, output and inflation.
Institute of Economic Affairs and Cass Business School
Founder, Lombard Street Research
Financial Markets Group, London School of Economics
Chief Economist, Invesco Perpetual Group
Managing Director, Europe Economics
Michael J. Oliver,
ESC Rennes School of Business
Lombard Street Research