No money, no inflation the role of money in the economy

Abstract

Most people think economics is the study of money.But there is a paradox in the role of money in economic policy, which is this: the attention actually paid by central banks to money has declined, whereas in fact, price stability is recognised as the central objective of central banks.It is no accident that during the "Great Inflation" of the post-war period, money, as a causal factor for inflation, was ignored by much of the economic establishment.In the late 1970s, the counter-revolution in economics -the idea that in the long run money affected the price level and not the level of output -returned money to the centre stage in economic policy.As Milton Friedman put it, "inflation is always and everywhere a monetary phenomenon".If inflation was a monetary phenomenon, then controlling the supply of money was the route to low inflation.Monetary aggregates became central to the conduct of monetary policy.But the passage to low inflation proved painful.Nor did the monetary aggregates respond kindly to the attempts by central banks to control them.As the governor of the Bank of Canada at the time, Gerald Bouey, remarked, "we didn't abandon the monetary aggregates, they abandoned us".So, as central banks became more and more focussed on achieving price stability, less and less attention was paid to movements in money.Indeed, the decline of interest in money appeared to go hand in hand with success in maintaining low and stable inflation.How do we explain the apparent contradiction that the acceptance of the idea that inflation is a monetary phenomenon has been accompanied by the lack of any reference to money in the conduct of monetary policy during its most successful period?That paradox is the subject of my talk.Of course, some central banks, especially the Bundesbank and the Swiss National Bank, always paid a good deal of attention to monetary aggregates.But when the European

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