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Money Supply

Volume 975: debated on Monday 10 December 1979

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asked the Chancellor of the Exchequer whether in fixing the monetary target in the range 7 to 11 per cent. compared with the forecast rate of inflation of 17 to 20 per cent., it is the Government's intention to reduce real wages in manufacturing industry by 10 per cent.

The short-term relationship between monetary growth, inflation and real incomes is complex and variable. In the short term, the relationship between monetary growth and prices and output depends on the velocity of circulation; and, except in the very short-term, the growth of real incomes is inversely related to inflation. In the long run, however, the velocity of circulation is broadly stable, there is a close relationship between monetary growth and inflation, and real incomes grow in line with productivity.The Government's policies, which are aimed firmly at the long run, are designed to secure a progressive reduction in monetary growth and inflation, which in turn will provide the best possible base for sustainable increases in productivity and hence real incomes.

asked the Chancellor of the Exchequer whether he estimates that British industry can increase its output in the absence of an increase in the money supply to match the increase in the cost of living without a cut in real wages; and, if not, how existing output will be sold in the home market in the face of the reduced demand.

It is possible for output to rise when the money supply grows more slowly than the cost of living even if real wages are not reduced. Furthermore, one of the conditions essential for reducing inflation is that the money supply should grow less quickly than nominal GDP, in which circumstances the velocity of circulation necessarily rises. As inflation comes under control, and provided real wages are at levels which permit proper levels of profits, the rate of growth of real output can be expected to increase, and the rates of growth of money supply and nominal GDP to approximate more closely to one another.

asked the Chancellor of the Exchequer what increase in M3 would be required to finance an increase in exports to eliminate the expected deficit on the current account balance of payments in 1979–80; and how the increase in exports could be financed within the present target range for M3 in the absence of overseas borrowing without a reduction in the supply of goods and services to the home market.

There would be little purpose in attempting to make an estimate of this kind. To the extent that a tight monetary policy acts as a constraint on the finance of exports, it also restrains the purchase of domestically-consumed imports.

asked the Chancellor of the Exchequer if he will list the reason why he considers that in present circumstances an increase in the money supply over and above the target rate will lead to an increase in prices if (a) it is saved, (b) it is spent on imports, (c) it is spent on United Kingdom manufactures, (d) it is spent on services or (e) it is spent in some other way.

An increase in money supply must be associated with an increase in price, output or the velocity of circulation, or a combination of them. In the long run, output growth is determined by the growth of productive potential, and velocity does not change very much. Increases in monetary growth are therefore reflected in increases in inflation. This is true whatever the initial response to the increase in money supply is.In the short run, the relationships are much more complex. It would require disproportionate time and effort to explain all the relevant factors.

asked the Chancellor of the Exchequer what effect on the level of economic activity the successful achievement of the target increase in the money supply will have, given that the rate of price inflation is greater than the above target increase.

This will depend on how quickly pay increases respond to the lower rate of monetary growth.