The quantity of money

After considering what is money and how it is created, the next step is to look at how much there is, how the quantity changes over time, and what this is telling us. We are in luck because we can look at real data.*

Below I plot the amount of money in circulation in the UK over the last 3 decades. Money is a bit difficult to measure because it depends on what counts. This plot is for the broadest measure called M4 which includes credit and bonds. You can read about it and download the data from the Bank of England website.

When I saw this data I was shocked. Yes we all know that the global financial crisis was a big event and we are still reeling but I had not fully appreciated how dramatically things changed around 2008. Is this the end of neoliberal capitalism as some are suggesting? Look at the curve before 2010. The money supply keeps on growing. This could be regarded as normal. [Note added 17/08/2017: The growth in the money supply is demand driven. Money is created by households, business and governments borrowing on the basis of a promise to do something.] During the Lawson boom of the late `80s, the money supply was growing so fast that inflation rose to 8 percent and interest rates were increased to 15 percent in order to slow the rate of increase which led to the 90-92 recession. A classic boom and bust. But even during the bust, the money supply kept on growing – just at a slightly slower rate. And after 1992, the money supply kept on growing. As Raghuram G. Rajan said in his book Fault Lines, the policy was to “let them eat credit”, and we did. But then in 2008 everything changed.

The phase transition

In 2007-08 we knew we were in trouble and in 2009 the Bank of England decided to inject new money via quantitative easing (indicated by the black bars). The amounts were big – £200 billion in 2009 – but in terms of the total money supply it was a drop in the ocean and did very little. After 2010 the money supply began shrinking again – this was not normal. In 2011 and 2012 the Bank of England did more quantitative easing. Again the amounts were big but it had no noticeable effect. There was a bit of a pick up in 2016, then we had the referendum, more quantitative easing, but still the rate of money growth was no better than the ’90-92 recession.

Looking at the graph as a whole, the difference, before and after 2010 is stark – physicists call this a phase change, economists might call it a complete failure of monetary policy. So what exactly did change? The best explanation has been given by the economist Richard Koo (this is one of my favourite economics talks of all – my favorite moment is when Koo says “we live in a very strange world”). He calls our debt hangover a balance sheet recession and it works like this: For money to be created there needs to be borrowers but after 2010 there were too few borrowers, because rather than borrowing, people, companies and government were all trying to pay down debt, destroying money in the process. Consequently, rather than the normal phase where the money supply grows exponentially over time, after 2010 we observe an anomalous phase where the money supply is at best flat and at worse actually falls. It could have been fine if only households had decided to save but when individuals, companies and government all decide to pay off their debts at the same time then the economy stalls. Keynes called this, the paradox of thrift – saving is a virtue unless everyone does it.

Exactly the same kind of debt overhang or balance sheet recession happened in Japan after 1990. The lesson from Japan is that there is no quick fix. You can move the debt around, from private to public but the only way out is growth. Japan at least has a relatively strong manufacturing base, and relatively low inequality which both help growth.

What did not work?

In the UK, the government had hoped that by reducing corporation taxes they would encourage companies to borrow, to invest, to raise productivity and grow the economy, but it did not happen. At the same time they were trying to reduce government spending.  The Oxford economist Simon Wren Lewis calls this, “the most damaging UK macroeconomic policy mistake in my lifetime”. The problem is that if households are paying down debt and governments are reducing spending then comsumers have less surplus money and there is a lack of demand. If there is no demand, companies have no incentive to invest and the virtuous circle of rising production, rising wages and rising demand cannot begin. Also, by lowering corporation taxes, companies can increase profit without trying. If you look at the graph in Follow the money you can see that only corporations are sitting on a surplus. Households are back in the red which cannot last long.

End game

To end I will switch to a recurring theme. Throughout history, empires or economies fall not because the workers stop working, but because the elite become lazy, greedy, or corrupt. Economies stall when the elite focus on rent extraction rather than production. The historian Mikhail Rostovtzeff sums up the problem in this passage:

The prevailing outlook of the municipal bourgeoisie was that of the rentier: the chief object of economic activity was to secure for the individual or for the family a placid and inactive life on a safe, if moderate, income. The creative forces which [….] produced a rapid growth [….] suffered a gradual atrophy, which resulted in an increasing stagnation of economic life.

Rostovtzeff, M., The Social and Economic History of the Roman Empire, OUP 1957.

Sound familiar? The rentiers of today are the CEOs, the banks, the buy-to-let landlords, the stock market investors. They have no need to innovate, no need to find new ways to create wealth, because they are doing just fine while the rest are struggling. Until we rebalance tax incentives away from rent extraction towards production, until we switch power away from the financiers and back towards entrepreneurs and small business, and address the failing ratio of wages to capital, until then we cannot expect a more favourable outcome.

*In science there is data. Sometimes there is a theory – a hunch. Scientists test hunches by collecting data and then decide if a theory is useful. A theory without data remains no more than speculation. If economics wants to be a science, it can only do so by focusing on the data. Repeat after me. “No science without data.”


  1. Lallygag26 -

    Money supply alone doesn’t create inflation. It is a mismatch of money to real resources that does that – too much money chasing too few goods. In real terms doubling or tripling benefit levels (for example) would not be inflationary – people in receipt of benefits barely have the means to exist, yet as a country we consign vast quantities of food and other consumables to the bin every day. Clearly a case of too little money chasing too many goods. The same applies to many workers in the precariat economy – zero hours and insecure part time employment and to those in the public sector who have seen wage freezes or even pay cuts over recent years.

    The BoE is not injecting money into the economy as a whole through QE, it goes to the banks and to the markets (through the re-purchase of bonds). That money is either going into corporate sector savings or into asset purchase (the rentier economy you describe).

    You refer to rising wages, production and demand as a ‘virtuous circle’. The population as a whole already buys and wastes more than we need on a daily basis, whilst many (working or otherwise) struggle to pay their transport to work, the bills to keep their homes warm in winter, put food on the table for their families. CEOs and senior staff, on the other hand, take home exponential salary increases year on year. Addressing this inequality and taking a redistributive approach through government policy is what is needed. The mindset of our politicians and global corporate leaders is very much neoliberal, the press reporting the death of this agenda is greatly exaggerated, I fear. But it should be challenged – in a world where our environment itself is under threat it should surely be our aim to find an economic policy which could promote a vibrant life and grater equality without looking to ever increasing consumption as the only driver of that life.

    You include private households paying down debt as part of the overall problem. That would be the case if it was true, but it is not. Part of the ‘balance sheet’ is that a surplus in sector has to be balanced by a deficit in another -that is how accounting works.

    Your reasoning at the end relies on changes in government tax policy to affect the necessary changes in business attitudes and certainly that is one of the policy tools that government needs to bring into play. But you don’t mention government spending – which would have a far more immediate and beneficial effect in addressing the issue of inequality.

    Your postscript is wrong, I am afraid. A theory is not a hunch. When scientists observe phenomena they make assumptions about cause, correlation, etc. They form a hypothesis from their observations (which would be the ‘hunch’). Once the hypothesis has been subjected to rigorous testing and falsification then a theory is produced. A theory is as close to fact as science gets (science always allows for further data to change theories). The Theory of Evolution or Einstein’s Theory of Relativity aren’t ‘hunches’.

    1. Charles Adams -

      Thanks for the comment.

      Money supply alone doesn’t create inflation. It is a mismatch of money to real resources that does that – too much money chasing too few goods.

      Yes I agree.

      promote a vibrant life and grater equality without looking to ever increasing consumption

      I agree, consumption is just another word for spending and spending does not have to be environmentally destructive. Consumption might also include paying to listen to a local choir singing.

      Part of the ‘balance sheet’ is that a surplus in sector has to be balanced by a deficit in another

      Yes I know see my previous articles.

      But you don’t mention government spending

      I do. I quoted Simon Wren Lewis on the policy mistake of austerity. I addressed fiscal policy in more detail in my last post.

      What you say about theories is not different to what I said. We are both describing the scientific method. What you describe starts with observation which means collecting data.

      Einstein built on what went before but if relativity had not been confirmed experimentally it would have remained a hunch and we would probably have forgotten it by now. Of course, I am being a bit provocative. Really my point is that theory and experiment/data are symbiotic. The problem in economics is that there are plenty of theories but only rarely are they compared with data – show me an economics textbook with graphs where theory and data are plotted on the same axes!

    2. Ralph Musgrave -

      Agreed. Charles Adams’s article is a muddle.

      1. Charles Adams -

        Would you like to elaborate? Incidentally I tired to email you about positive money meetings but may be email address you use here does not work? Can you email me or add a post with an address I can use?

  2. Geearkay -

    Another great article – thanks for that.

    But – you’ve included a second asterisk point in para 5 (“…but when individuals, companies and government** all decide to…”) – There doesn’t appear to be a corresponding footnote.

    Sorry for the pedantry 🙂

    1. Charles Adams -

      Thanks I removed them.

  3. Mark Crown -

    To be honest Charles what you seem to be describing is my biggest fear – the beginning of a new era or rentier dominance – the bastard son of neo-liberalism.

    I do hope that Corbyn keeps getting out there and that various progressives work together to take this on.

    I have joined a local progressive alliance where I live and I hope to promote fairness in society through the shared economic ideas that we have through the likes of Richard Murphy and others. I hope that I am up to the task!

    1. Charles Adams -

      There is no reason it has to go this way. We may be at a turning point which is why it is so important that as many as possible are equipped with the knowledge to move forward in a more productive direction. Richard is inspiration to us all of what can be achieved by sharing ideas.

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  5. Andrew -

    You identify the problem as being elites focusing on rent extraction rather than production. In this connection, it might be worth mentioning the problem of stalling productivity, not just in the UK but elsewhere too. As Paul Krugman famously said, “Productivity isn’t everything, but, in the long run, it is almost everything.”

    You also mention the “relatively strong manufacturing base” in Japan. Manufacturing output in the UK is about £360 billion, which is about 3% of the world production (on less than 1% of the world population) and still in the world top 10, although admittedly a smaller fraction of the economy as services have surged ahead. Manufacturing production in Japan is about four times that, with about double the UK’s population (their productivity is about twice ours). We are also significantly behind China, the US, Germany and Korea in absolute terms, and also – apart from China – per head. But we are comparable with France or Italy, and we are significantly better than say Canada or Mexico, or even Brazil or Russia or Turkey.

    1. Charles Adams -

      Good points. I agree with Krugman, roughly productivity = prosperity. The ‘elite’ should be rewarded for increasing productivity/prosperity and sharing the gains fairly rather than e.g. shareholder value.

  6. Graham -

    We are in this mess because of politicians. They are incompetent, possibly corrupt, captured by the rentiers and interested only in their “hunches” and not data. i.e. they are driven by political dogma and are contemptuous of evidence. We need to be rid of them and create a deliberative democracy, not an oligarchy, which is what we have at present.

  7. Simon -

    Could you detail exactly which data you used from the BoE site?

    I’m assuming you were using the BoE statistical database, so could you give a level-by-level pathway to the data you used:

    This database has a number of slightly different sets of data for M4 and the ones I looked at gave similar but slightly different graphs to the one you have presented, with a slightly more pronounced fall from 2010 and rise from 2016.

    Which of these various BoE M4 data sets is the best overall representation of M4 supply?

    1. Charles Adams -

      I used LPMAUYN

      You can enter this code in their search here.

      Hard to say which is best. Could probably write a PhD on how best to measure the money supply.

  8. Bill Kruse -

    Maybe QE didn’t have the anticipated effect as its real aim was to switch toxic assets from bank balance sheets with what we might call sound money, in so doing neatly distancing them from the insolvency many arguably should have declared. Any beneficial effect on the broader economy might have been regarded as a bonus, the prime motive being to save the zombie banking network in a discreet manner.

    1. Charles Adams -

      Do you know where most of the QE money ended up? Were the bonds bought on the open market or from specific institutions?

      1. Bill Kruse -

        I believe it ended up, as was intended, it started and ended, in bank reserves at the BofE. The banks surrendered bad paper, the toxic assets, mortgage-backed securities which were worthless, in return for QE-generated money. I remember being indignant at the time as I couldn’t find out what specific values, what worth, was being given to these actually entirely useless ‘assets’ so I don’t know how much they were swapped for. I assume it was at some imaginary market value as there would have been no point in the exercise otherwise. While I was trying to find something specific about this, incidentally, I came across this, which is interesting in general, I thought

  9. Allen Bell -

    What’s the reason for the non-linear y-axis? At first it looks like there is an attempt to mask the massive uptick in M4 during the Brown years.
    It’s interesting that aggregate M4 across the last 7 years is the highest of any similar length period in history. Yet because some people are worse off we call this austerity and claim that overall government spending has been insufficient, rather than badly allocated.

    1. Charles Adams -

      Given that we would expect exponential growth a log y axis is appropriate, then steady growth leads to a straight line. Only if there were no growth and no inflation might you expect M4 to remain constant. The fact that it is not growing at all is rather exceptional.

  10. Alexander Kurz -

    “the normal phase where the money supply grows exponentially over time” — how can exponential growth be normal? How can it be sustainable? In the long run, can we afford an exponentially growing economy? At least in the natural world exponential growth is never sustainable in the long run. How can it in economics?

    1. Charles Adams -

      It’s a good point. As the co-founder of Intel Gordon Moore says “no exponential can last forever”. However, money is only information, a record of human interactions, and exponential growth of money is unbounded, just like numbers in mathematics. The physical limit to growth is energy and the way in which its use is destructive. We must smarter about so we do not destroy the planet, but growth can also arise from being more energy efficient and making better use of resources.

      1. Peter May -

        Ann Pettifor thinks ‘growth’ should be replaced with ‘economic activity’ – to include employment, investment and output.

  11. David Malpas -

    What will be most interesting is to see how money circulation evolves over the next few years as global central bank balance sheets are trimmed. The Fed should start unwinding it’s balance sheet (albeit slowly) in September. The ECB will taper QE possibly in January, perhaps stopping QE by 4Q18. They really have no choice to taper QE since they are running out of government bonds to buy (they are not allowed to deviate from the capital key). The PBoC has been reducing it’s balance sheet since 2009. So by end 2018, only the BoJ may still be expanding. CB balance sheets will only expand around 1% of GDP in 2017 (compared to an average liquidity injection of around 2% of GDP since 2011). This will go to flat in 2018 and could become a reduction of 1%+ of GDP by end 2019.

    I think that central bankers are much maligned in the media (by both left and right). The problem is monetary policy was never built to solve the structural problems that many Western economies face (such as demographic changes). The central banks were there to provide breathing space for fiscal policy. But with governments asleep at the wheel, central banks put their foot to the floor (within their limited mandates), putting policy rates at the zero bound (or lower in some countries) and a host of unconventional policies (QE, operation Twist, TLTROs, ESM etc). They now are in a difficult position since the side effects of this policies (too much credit lending, higher corporate balance sheet leverage, low govt bond yields/high asset prices forcing higher savings rates) have become dangerous. If they don’t tighten policy, they could also find themself out of bullets as the next recession looms. If they do tighten policy, they could trigger the next downturn.

    1. Charles Adams -

      The central banks were there to provide breathing space for fiscal policy. But with governments asleep at the wheel, central banks put their foot to the floor

      and created more danger. Thanks that’s a brilliant summary.

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