A New Year’s Resolution for the Bank of England

The One Hundred Twelfth United States Congress opened the year with a reading of the American Constitution. Though this was probably more of a show than anything, it does serve a useful function. For better or worse, this government has been elected to serve the electorate to the best of its ability and within the confines of what the law permits. The American Congress was originally granted territorial monopoly rights to make and change the law of the American land. It was not, however, given free rein in this regard. The power of the Constitution is that it delineates the extent of the power endowed to Congress by the people, and where those powers end.

While it is refreshing to see the political establishment paying at least lip service to its original grants and privileges, there exists one other set of territorial monopolists that must be reminded every now and again of their purpose.

The world’s central banks – the Federal Reserve in the States, or the Bank of England for the United Kingdom as examples – were granted a territorial monopoly right over the issuance and control of the money supply in their respective jurisdictions. This grant was not made without limits. These limits are what are widely recognized as keeping these monopolists free from outside interference, but also preventing them from unduly interfering with the events outside their domain.

Perhaps the governors of the Bank of England should start each New Year by gathering around Mervyn King while he reads the original purpose of the Bank. While its scope and mandate is now a little different than the original 1694 Bank of England Act, the Bank’s own website very neatly outlines what its principal objective is, namely “to safeguard the value of the currency in terms of what it will purchase”:

Rising prices – inflation – reduces the value of money. Monetary policy is directed to achieving this objective and providing a framework for non-inflationary economic growth. As in most other developed countries, monetary policy usually operates in the UK through influencing the price at which money is lent – the interest rate.

Two points become clear. First, safeguarding the currency’s value is the primary focus. Second, this will be done so as to promote non-inflationary growth.

The problem is that the Bank of England seems not to realize what the word “inflation” means. It is not only their confusion. The word “inflation” may be one of the most misunderstood and misused words in the English language. Murray Rothbard, on page 990 of his 1962 opus Man, Economy and State, defines in no uncertain terms exactly what inflation is:

The process of issuing pseudo warehouse receipts or, more exactly, the process of issuing money beyond any increase in the stock of specie, may be called inflation. A contraction in the money supply outstanding over any period (aside from a possible net decrease in specie) may be called deflation. Clearly, inflation is the primary event and the primary purpose of monetary intervention.

Any increase in the quantity of money outstanding constitutes inflation. While the Bank of England concentrates on the general price level, it ignores this very important point. After all, the price level can and does change constantly as resource availability alters the relative scarcities of goods, and our own preferences change the values (and hence purchase prices) that we assign to those same scarce goods. Only a definition of inflation grounded in the actual quantity of money gets to the root of the problem: changes in money’s quantity alter its purchasing power.

Second, the Bank seems to want to foster an environment of non-inflationary economic growth. Ignoring for the moment whether the bank is actually pursuing a “low-inflationary” policy, can we say that it is fostering a growth policy?

Given the current state of affairs, which seems to get worse by the day, the unequivocal answer is: no. The United Kingdom’s most pressing problem at this moment is crushing debt levels. The government alone has a little less than 70 percent of the country’s GDP tied up as debt. Interest payments on this debt alone eat away about 3 percent of British GDP each year. The payments on this debt load are stifling, and will only grow over time. One may ask what happened to create such an indebted nation.

The Bank of England’s inflationary policies, since it was nationalized in 1946, have been staggering. As the pound lost value through these policies, an environment where debtors were rewarded for borrowing at the expense of the more prudent creditors was bred. The home of the Industrial Revolution, a once-great source of exports to the world, now finds itself needing to borrow from the world just to meet the interest payments on its debt. This does not sound like a situation that promotes “economic growth”, as the Bank of England eloquently puts it.

Yes, Mervyn King and the rest of the Bank of England would do well to revisit their purpose and mandates at the start of each year. But they would also be well-advised to learn some basic economic theory while they’re at it.


  • The above article is just semantics.

    A word in the English language (or any other language) means whatever it is commonly used to mean. Period. Full stop. End of argument. And nowadays, the word refers to price increases (roughly speaking).

    The word “inflation” USED to refer to a money supply increase: around twenty or thirty years ago. Its usage then changed. I actually wrote to the Oxford English Dictionary about twenty years ago and pointed out the change of usage. They duly changed their definition, though doubtless they would have noticed the change of usage without my assistance.

    The claim in the above article (backed by the quote from Rothbard from 1962) that inflation “really” means a money supply increase is thus not true. The word USED to have that meaning, but not nowadays.

    Of course the motive in trying to re-attach the “money supply increase” sense of the word to the word inflation in the above article is obvious enough. It is an attempt to persuade us that inflation always and necessarily derives from a money supply increase. Well I’m not so easily fooled. For example a big increase in irrational exuberance, even given a constant money supply, would probably raise inflation.

    Isn’t the author of the above article aware of the fact that governments tried to control inflation by controlling the money supply up to about seven years ago? They failed utterly because the evidence is that there is little relationship between the money supply and inflation (unless we’re talking completely lunatic rates of money supply increase a la Mugabwe).

  • waramess says:

    If we give paper all the atributes of gold then paper will behave like gold. Conversely should we give to paper all the attributes of paper then it will behave like paper.

    Paper dollars and sterling are losing value against commodities because of the flood of paper let loose on the markets by QE and even a child can see how to correct this.

    Central banks will prefer to increase interest rates in order to give greater value to this paper money. Anything but the real thing…..

  • chef says:

    Ralph Musgrave, you’re my hero :) I agree entirely with the points you raised.

    Mr Howden and money reformers like him live in a world where the economic pie is fixed, so any increase in the supply of money upsets the delicate balance and fuels inflation. As he admits in this article that’s patently not true, there are other factors such as resource availability or government legislation (i.e minimum wage policies) that arguably have a bigger impact on the retail price index.

    I don’t know the figures of the top of my head but I suspect there’s been a huge increase in M0 type money since 2007, without a corresponding increase in inflation; this is because the money isn’t being used.

    I do believe we need some sort of reform, but jamming the monetary system to create a shortage of currency will only create more harm than good.

  • joebhed says:

    This is the essence of why there is a lack of a coherent discussion about monetary reform.

    You start out – correctly – with the Bank of England Act defining inflation as rising prices, and you transfer the inflation notion over to Rothbard’s specie mantra,as if Murray was somehow infallible on things monetary.

    So, which is it?
    Is inflation the constant increase in general prices, with the currency constantly buying less?
    I think so.
    Need to fix it.

    Or,is inflation ANY increase in the quantity of currency-denominated media, even if the design and purpose of the increase is actually to maintain price stability- and especially if that policy is successful?
    I think not.
    No inflation here.
    No problem.
    Steady on the helm.

    To increase the quantity of media along with GDP is to maintain price stability, is to maintain economic stability and is actually to maintain monetary stability in terms of its stable buying power.

    That’s what money is for.

    Sorry, Murray and friends.

  • Current says:

    I think there is a lot of truth in the posts criticising this article…

    The question about inflation isn’t simple “how should it be defined”? It can be defined in several ways. The important question is what sort of inflation harms long run growth? You can argue that any sort of money creation does so, which is clearly David Howden’s view, I wouldn’t agree with that. But just by saying that inflation was defined differently doesn’t help much.

    The redefining of inflation was certainly a rhetorical trick, but that doesn’t mean that it shows that the old definition was better. In Mises early books he uses a different definition again.

    Above Ralph Musgrave writes: “because the evidence is that there is little relationship between the money supply and inflation”

    It’s not as simple as that. In normal times there is often quite a strong relationship between some monetary aggregates and prices. But, these break down in abnormal times such as these. That breakdown justifies abandoning mechanical quantity theory.

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