Monthly Monetary Updates 2020

An archive of Professor Tim Congdon's Monthly  Monetary Updates from the year 2020. In this archive you can find a link to his Monthly Note videos, the Money Notes (PDF) and also the slides used in the Monthly Notes (PDF). 

stacks of bank notes

December:

(No video was produced in December)

November: On Alice-in-Wonderland government bond yields in the UK

There was a sharp acceleration in broad money growth in the UK in 2020. This has been caused by the response of the government and the Bank of England to the coronavirus pandemic. At the time this video was produced, the Bank of England had just announced a further £150b. extension to its asset purchase programme, completely unnecessary in the opinion of Professor Tim Congdon, who pointed out that there is no sign of financial strain in the UK. This will create a further upward blip in the quantity of money, taking the annual growth rate above 15% by mid-2021, which will result in inflation rising above 5% in the next 2-3 years.
Yields on Consols (one type of government bond) were low and stable – around 2% to 3% for over 200 years. Yields rose sharply in the 1960s and 1970s due to inflation, which peaked at 26.9% in August 1975. Consols lost 85% of their nominal value between 1946 and 1974 and the real value fell between 1945 and 1976 by 97%. Index-linked government bonds were introduced in 1981 as a result of the losses made by investors on bonds. Now, however, these too are giving a negative yield. These poor yields are a particular concern because of rising levels of government debt. What is astonishing, however, is that the ratio of debt interest to GDP has been going down, possibly because most investors are expecting lower inflation in the years after the coronavirus pandemic. If the cost of borrowing were to rise, the interest payments on debt would rise sharply and this would produce a major crisis given the scale of public borrowing.

October: On negative interest rates and the 'liquidity trap" and how money affects the equity market

It is claimed that when the interest rate drops to zero, there is nothing more that central banks can do to stimulate the economy. The effective “zero lower bound” has been reached. Some central banks, such as the ECB and the Bank of Japan, have reduced interest rates to -½%. Why not do this in the UK? This video argues that such a move is unnecessary and may be counter-productive. When interest rates drop below zero, the central bank charges interest on its holdings of deposits from commercial banks. This is effectively a fine levied on commercial banks which reduces their profits. Furthermore negative interest rates would most likely result in yields on safe assets such as government paper going very low or even negative too. This would also be a hit to banks’ profits, affecting their ability to advance new bank credit. The Central Bank can always create more money by purchases assets. This does boost national income and expenditure in the medium term. Thye is why negative interest rates are never needed.
The video also considers the Liquidity Trap”, a theory first advanced by J M Keynes in the General Theory, published in 1936.  This arises when increases in the quantity of money do not lower bond yields. But what if the bond yield is already very low? Investors will expect the next move on yields to be upwards, resulting in a loss on a fixed-rate bond. In this sense, monetary policy is exhausted. However, investors do not have a choice merely between money and bonds. The bond market is actually very small relative to the overall size of the economy. The liquidity trap is therefore a very silly idea.  Nearly half of US household wealth consists of real estate or directly-held equities. These do not have a fixed rate of interest. Households and institutions like to keep a stable ratio of money to assets but equity markets are more volatile.  In 2009, the Bank of England’s QE operations caused the equity market to rise by 50%. A similar phenomenon took place in the USA in 2020. This shows how critical changes in the quantity of money are to the performance of the economy.

September: The worrying triumph of New Keynesianism

This video begins with a consideration of the money numbers in several leading economies, which are falling from the peak values seen earlier this year, but still remain very high. The main focus is on New Keynesianism, which dominates the thinking of the US Federal Reserve and other leading central banks.
The 1970s and 1980s saw a “monetarist counter-revolution” with Milton Friedman a particularly influential figure. Monetarists like Friedman insisted that inflation was always and everywhere a monetary phenomenon and rejected fiscal expenditure to stimulate the economy. Monetarism was responsible for bringing inflation down but since the late 1980s and 1990s, it has fallen out of favour in favour of New Keynesianism.  Academics claimed that it did not create a satisfactory level of employment. In 1999, an influential book entitled The science of Monetary Policy, a new Keynesian Perspective, written by Richard Clarida, Jordi Gali and Mark Gertler, was published, which claimed that the economy can be described in three equations – the IS equation, the Taylor Rule and the expectations-augmented Philips Curve. Money was ignored, the labour market was viewed as more important and fiscal activism was encouraged as a means of stimulating the economy when interest rates dropped to zero. Fed Chairman Jay Powell has been influenced by this school of thought. He recently claimed that inflation expectations were the principal drivers of inflation and also said that he expected inflation to be subject to downward pressures for some years in the future and that the US would struggle to see inflation rise above 2%.
The video concludes by considering the IS curve, which purports to show a relationship between interest rates and output. A graph comparing the Fed Funds Rate and the growth of US output since 1954 shows that there is no relationship between the two. It should be the case that when interest rates go up, output goes down, but this isn’t true. A much closer correlation exists between broad money and GDP. This is why the Institute disagrees with Powell’s assessment of the US inflation prospects – broad money growth shot up in 2020 and is likely to be followed by a sharp rise in inflation.

August: 2020's Global Money Growth Surge: inflation implications

This video looks at the global monetary scene. The development of a vaccine for coronavirus means that by mid-2021, the world should have returned to normal. However, there will be a legacy because of the surge in broad money growth in most advanced economies in the last six months. Between the end of February and the end of June, policymakers in the advanced countries did everything they could to promote economic activity at a time when the lockdowns had a devastating effect on some industries. This led to a dramatic increase in the quantity of money, with the US seeing the most extreme growth. By contrast, the two developing countries, China and India, saw only modest increases in the quantity of money. Canada has seen money growth on a scale only exceeded by the USA.
The net result will be a strong rebound in 2021. Asset prices are very strong around the world. There will be a lot of pent-up consumer demand and inventory rebuilding. Apart from the USA and perhaps Canada, inflation should not be too problematical if central banks take prompt action to reduce broad money growth.  In the USA, there is talk of a huge fiscal package, which if financed by the Fed and commercial banks, will further boost the quantity of money.

July: Putting the coronavirus pandemic in a long-run macroeconomic context

This video looks at the USA where broad money growth rose by 26.7% in the three months to June. Milton Friedman believed that the rates of change in nominal national income (or GDP) and broad money were closely related over the medium and long term. He proposed that the right thing for policy was stable growth in the quantity of money using a measure which included time deposits – what is now called M3. The US data going back some 100 years is analysed. Up to 1959, broad money growth was very unstable and this encouraged Friedman to advocate low and stable broad money growth. Things were less turbulent in the ensuing 60 years. Broad money growth was less erratic and nominal income/GDP also grew at a more stable rate. Changes in the velocity of money have tended to be fairly modest over the last 70 years and ted to be mean reverting. Applying this analytical framework to 2020 (And there is strong evidence that it works), if the current explosion in broad money growth accompanied by a collapse in the velocity of money is followed by a jump in the velocity of money, the US economy is likely to follow a similar pattern to the last period when broad money growth was this high – 1943. Four years later, US inflation hit 20%. Velocity returned to its mean reverting trend in 1949 thanks to two years of minimal broad money growth. A rise in inflation in 2021 is therefore to be expected. The Fed is currently expecting a very different outcome, however, and intends to maintain an accommodative monetary policy “for many years”!

June: Coronavirus pandemic, the quantity of money and asset prices.

This video looks at the global money scene. The USA has seen a huge splurge in broad money growth taking the annualised three-monthly growth rate up to almost 90%. This points to higher inflation in the next two years. The asset balances of many financial institutions have also increased significantly, hence the surge in the US stock market since the end of March. The Fed has reduced its asset purchases in recent weeks, but it is just a pause in the fiscal and monetary spree. Looking at other countries, they show a similar “hockey stick” graph of broad money – relatively stable broad money growth followed by a sharp increase since March 2020. The accelerations are, however, of different magnitudes.  As for the developing countries, India has seen a modest acceleration in broad money growth while although in China, there has been an uptick it has been pretty minor compared with elsewhere.
The pattern is similar, enlarged budget deficits financed by the banking sector and large-scale asset purchases have resulted in an acceleration in broad money growth. Asset prices have done very well but once the pandemic is over, excess money balances will result in above-trend growth and upward pressure on inflation.

May: The coronavirus pandemic, money growth and asset prices

This video once again looks at the USA where money growth has risen to levels not seen in well over 40 years. Professor Congdon stressed that this video is not investment advice, but the likely effect on asset prices is an important discussion point. The US Fed is concerned that asset prices will fall. The Institute is stressing the opposite – namely that at the time this video was made, there was an asset price bubble which had further to go. This argument is based on money. Fund managers have a great deal of money to invest at the moment. They do not wish to hang on to too much cash – indeed the ratio of money to equity/assets has  proved remarkably stable over the medium to long term. A study of the UK over a 30-year period finds very little change in this ratio, even though the amount of money has increased significantly. In the USA, the stock market was already doing well in 2019. Given the huge jump in broad money growth in 2020 and the volatility of money held by the financial sector (Which are up by 50% on the level of 2018) and that investors are holding more money than normal, the market will go up and will be followed by an inflationary boom in 2021, especially as monetary policy is likely to remain loose, keeping broad money growth high.

April: Will the coronavirus pandemic cause an inflationary boom? (Part 2)

Professor Congdon expresses his concern about monetary developments in the USA.  In March, he observed that broad money growth had been accelerating. Since then, things have changed. US broad money growth has shot up and could reach the highest level in peacetime history, pointing to double-digit inflation in the next two or three years.
An enlarged US budget deficit, largely financed by the banking sector (including the central bank) plus a commitment by the Fed to lend to distressed bank will cause broad money growth to increase. Now the US budget deficit, originally forecast to be about 8% of GDP in 2020, could reach 14% - another peacetime high. The so-called “stimulus checks” are a large part of the enlarged deficit. In one single month – March 2020, US broad money rose by 3.9%, higher than the figures for some entire years. Bank deposits went up by 5.6% during the same period. The “stimulus checks” are likely to result in broad money rising at an even faster rate in April. These figures stand in sharp contrast to the stability of the previous decade.  In 2020, there will be a fall in GDP an also the velocity of money will fall, but with broad money growth on the current scale, this points to an inflationary boom just as there was after the two World Wars when broad money growth reached similar levels.  While governments had to do something to address the pandemic, the response has been disproportionate.

March: Will the coronavirus pandemic cause an inflationary boom?

The policy response to the coronavirus could well cause an inflationary boom. The pandemic will one day be over and normality will return.  Governments are treating the current situation like a war and are planning to increase their spending. Wars cause inflation because governments spend more money. They cannot raise taxes so they borrow from banks, creating new bank deposits which are money. This is exactly what is happening in the USA – extra medical spending, support for distressed businesses such as airlines and “stimulus checks”. In total, these measures could cost $1.2 trillion, doubling the US budget deficit to similar figures seen in the war. This is an election year and President Trump doesn’t want to be seen as a skinflint.  US M3 was growing by about 8½% at the end of 2019, the highest figure for 10 years. Broad money growth is likely to rise to higher levels – maybe to 10%, which usually presages a boom then inflation.
Similar phenomena are likely to be seen in the Eurozone and the UK. The Office of Budget Responsibility said that the UK must not be “squeamish” about debt. Something like £80b. of short-dated gilts could be issued in 2020, pushing up broad money growth form 4% - 5% in 2019 to 7% - 8%. Central banks are being helpful and credit conditions are being eased. The extra money created as the policy response to the pandemic will result in households and individuals having higher than normal money balances. While there are falls in output due to the lockdown, this is not a “normal” recession.  It is a supply disruption not a lack of demand. If policymakers try to pump up demand and ignore the unique circumstances, the result will be inflation.

February: Monetary financing of budget deficits

This video was produced at a time when there were concerns about the coronavirus spreading from China to other countries. It is possible that 2020 will see a fall in Chinese output and possibly in world output. There is a widespread view that monetary policy is about the setting of interest rates to influence the growth of bank credit to the private sector. This is not the whole story. Banks must have some cash to repay depositors but they exist to make a profit for their shareholders. They are highly leveraged and fractionally reserved (their cash reserves are a small part of their assets). The deposits are the main items of interest as they are money. For the 60 years up to the Great Recession, expansions in bank lending were the main drivers of money growth. Banks can also have claims on the government, for instance if the government wants to finance a budget deficit by borrowing form the commercial banking sector (or, in more recent time, by QE operations) At the end of World War 2, the majority of both US and UK banks’ assets were claims on the state. It is likely that the coronavirus will give governments the pretext for increased spending - healthcare, for instance. There is currently a downturn in the world economy caused not by demand weakness but supply issues. Governments are likely to want to stimulate the economy. The USA is already running an unusually large budget deficit and in the UK, there is talk of increased government spending. Monetary financing of these programmes will raise monetary growth but will possibly increase inflation in the longer term.

January: Money or credit: which determines national income and wealth?

In late 2019, money growth was accelerating in the USA pointing to trend or possibly above trend growth in the USA. This assessment has been disputed because bank lending ot the private sector has not been particularly buoyant. However, Tim Congdon replied by pointing out that US government was running a huge budget deficit which was being financed by the banking system. There has been a long-running debated about whether bank credit or money matters in determining macroeconomic outcomes. Those favouring the former quote the “income-expenditure circular flow” model to support their views. In this system, extra credit can be seen as “positive shock “ to the circular flow. According to Greg Mankiw, one leading exponent of this view, the circular flow is “all the economy” but it isn’t. The value of all payments in the economy is much higher than the value of transactions in the circular flow.  If one buy a house which was built in say 1930, the transactions which were involved in building it (paying the construction workers, etc), took place a long time ago and are not part of the income-expenditure circular flow.
How does money fit in? Most new bank loans are made to finance the purchase of existing assets. They are not part of the income-expenditure circular flow. Money therefore is far more important than bank credit as it relates to all transactions. In conclusion, new bank credit is important only inasmuch as it creates new deposits, which are money.

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