Member-only story
The Bank of England was made ‘independent’ of the Treasury, although not really, so that it could take the blame for any decisions to increase interest rates, such as those taken earlier this week (£) when the Bank increased bank rate to fight inflation. Why would they do that?
Inflation is believed to have one of two causes, one is that there is too much demand, chasing too few goods and consumers bid up prices. The other is that import prices are rising and thus have an impact on the domestic price level. These are known as demand-pull, or cost push.
The monetarist theory is that there is a real world and money view of the economy.
i.e. Prices x Product = Money Supply x Velocity of Money or PQ =Mv
This equation is derived via definitions and algebra and thus there is no proof of causality. Monetarists say that reducing the money supply will reduce prices. This assumes that in the short term both the velocity of money and the amount of product are static. Recent econometric studies suggest that the velocity is not constant, and there has always been a problem of defining what money supply is as it must include some credit and so is very difficult to constrain. We should note that consumer credit can be increased very rapidly so can no longer be consider static.
