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QTI-The Quantity Theory of Inflation

Hector McNeill1

The Bank of England has got itself in a bit of a pickle by supporting government policies more ideological than economically rational. Their inappropriate policy instruments counter productive growth, cause inflation and depress real wages.

A witness for the Economic Affairs Committee stated quantitative easing is a policy without a theory. The BoE added that they are still trying to understand the effects of QE.

The relevant theory is the Quantity Theory of Inflation (QTI) and its logic counsels terminating what they are doing.

All of this presents a case study in why monetarism and Keynesianism provide no solutions to our current state of affairs, including falling real incomes, post-Covid recovery and tackling the climate change challenges.

This policy-induced prejudice requires an investigation as to the fundamental purpose of macroeconomic policy. Simply reacting to alternative proposals by asserting that there is nothing more to discuss, because there is no alternative, is a position that was no longer tenable with the 2008 financial crisis. But rather than contemplate a means of avoiding running up more debt, that is seek alternatives, the government and Bank of England opted for an intensification of financialization and debt.

There is, however, an alternative solution that lies in the terrain of the real incomes approach to economics.

It is well established that supply side organic growth is able to create more for less. This should be something of enormous significance in a world which is consuming more resources and diminishing the carrying capacity of the planet as an existential threat to mankind.

Cost push factors
  • Land
  • Housing
  • Retail units
  • Offices
  • Warehouses
  • Industrial units
  • Commodities
Excessive money supply at low interest rates:

Raising input costs, lowering margins and creating cost-push inflation, wage freezes and falling real income.

Depleting factors
  • Interest rates
  • Taxation
  • Offshore investment flows
  • Offshore profits remain offshore
  • Shares
  • Financial instruments
  • No savings income
Excessive money supply at low interest rates:

Lowering onshore investment and employment, raising competition from imports, offshore profits held or reinvested offshore or buying assets, national tax avoided, raising risk of investments in national supply side activities, wage freezes and falling real income.

It was well established in the mid-1900s that all "economic growth" is the result of learning by doing and the accumulation of human capabilities (tacit knowledge) and observation and evaluations through accumulated information (explicit knowledge) giving rise to innovation to advance supply side efficiency and productivity.

However, because this process is dominated by human capabilities to learn and innovate, this transition has a definite limit on its rate of advance that precedes any practical implementations and growth.

Technology transfer can help by disseminating state-of-the-art, but even this faces a limit on its delivery of rates of advance in the form of practical impacts for the same reasons, including the mudane issue of learning how to use it as well as adapt it to different circumstances.

This means that within the country, there is a limited ability or absorptive capacity on the supply side to make use of investment funds.

As a result money from any source including quantitative easing, modern monetary theory options and even grants and free money cannot alter this rate of growth because of the human factor. Throwing money at issues does not solve anything.

As a result excess money flows into speculative physical and financial instrument asset markets generating significant rises in asset prices. These markets are leaky, so house, land, industrial units, offices and retail unit prices and rentals rise along with some commodities transacted, not for their use, but purchased for speculative reasons (some of which are cartelised e.g. petroleum). These rising prices and rentals, generated by a policy of excessive money issuance and close to zero interest rates, leak into the costs of the supply side production units, both goods and services, causing cost-push inflation. This is because the rate of increase in input prices begins to exceed the ability of the supply side to increase the rate of innovation to raise compensatory levels of productivity. This leads to squeezed profits and the need to raise unit ouput prices causing a decline in real incomes of wage-earners.

Therefore, it is evident that inflation is not caused by "excessive demand" but rather has been caused by inappropriate central bank monetary issuances under prejudicial government policies2.

We therefore end up with a clearer justification of the logic of the real incomes approach designed to accelerate the rates of practical innovation. This is surely an alternative to the logic of monetarism described above and which can be summarised as a Quantity Theory of Inflation (QTI) which should replace the flawed Quantity Theory of Money (QTM).

Further reading (all in pdf format):

1  Hector McNeill is director of SEEL-Systems Engineering Economics Lab

2  Monetarists, and I might add, Keynesians, never understood slumpflation because of their fixation with "demand management". Slumpflation (rising inflation and falling employment) was caused by falling real incomes resulting from cost-push inflation, generated from massive price hikes in petroleum. The combination of a government with a leader with a tenous grasp of economics embracing the orientation of assertive individuals who proclaimed themselves "monetarists", initiated a disastrous period in our history. Interest rates were raised to extraodinary levels which exacerbated the crisis, resulting in a severe reduction in technological investment, money flowing into offshore investment undermining British manufacturing and employment. Totally sound mortgages taken out by families in good faith, were converted into sub prime mortgages as a direct result of the interest rate hike. As a result almost a million people lost their homes. The people, thus prejudiced, were never compensated by government for its irresponsible decisions.

A real incomes approach would have resolved this by continuing the substitution of petroleum over time and moving to a stabilised monetary volume with growth coming from techological advance. We had 45 years to achieve this but governments have continued their drive to remove financial regulations and financialize the whole economy in a grotesque experiment, with no underlying theory, placing constituent wellbeing in an increasingly precarious state; as highlighted by Covid-19. The fixation with money by governments and enterprises lost this important opportunity to rationalise our consumption of hydrocarbons because of the muddled logic and technological ignorance of monetarists and central banks, which continues to this day.

Only now with COP26 people are people waking up to the fact that the practical impacts of this cascade of insanity are getting "serious".

But, for the reasons explained above, monetarism can only exacerbate this crisis.

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