preferred means of reducing the money supply will inevitably be high interest
rates and/or reducing public expenditure. In many ways the theory is not so
much new, as a return to what was commonly understood as economic
orthodoxy before Keynesian ‘demand management’ became politically accep-
table. One political consequence of the popularity of monetarism has been that
the concentration on interest rate mechanisms for economic policy has
increased the importance ofcentral banksat the expense of government
economic departments, with attendant calls for them to be independent of
central government as in the US or German models. Thus the first important
announcement of the incoming Labour government in the UK in 1997 was a
return to independence for the Bank of England. Since the creation of the
Third Way, as espoused by the BritishLabour Party, the victory of mon-
etarist thought over British politics has become complete.
Money Supply
Money supply, which can be measured in various ways, is the account of how
much money in its several forms is circulating in an economy at any given time.
The simplest definition of money supply, referred to by economists as M 0 , is
simply notes and coins in circulation. Other definitions may include some or
all balances in various kinds of bank accounts, bank overdraft facilities,
spending power cumulated over the population’s credit cards, etc. It is easiest
to think of it as aggregate spending power, because this is why it is thought to
be vital in controlling economic factors like inflation. Changes in the money
supply also act as good predictors of underlying currents in an economy. In the
United Kingdom, for example, sharp growth in the money supply (and the
accompanying expansion of consumer expenditure) in 1987 and early 1988
heralded an increase in inflation and deterioration in the balance of payments
position that started in late 1988. Because of the close link between money
supply and inflation, controlling the former has become a major weapon for
governments wanting to control price rises without recourse to interventionist
strategies like direct price and income restraint. However, the money supply is
itself largely determined by government expenditure plans. When these
exceed tax income to the government, thedeficithas to be supported by
borrowing, usually from the banking sector, and these loans to the government
are effectively ‘new money’, thus increasing the money supply. Consequently
monetariststrategies of interest rate increases in order to restrict the money
supply have to be accompanied by progressive reductions in government
borrowing forcing cuts in public expenditure. However, it is not at all clear
that thereisa simple causal connection between money supply and inflation,
while other techniques to cut money supply, principally raising interest rates,
Money Supply