Problems with Broad Money

When monetary targets were introduced in the UK and then the importance of monetary control was re-emphasised in the Medium Term Financial Strategy (MTFS), £M3 was the measure of the money supply which was targeted. The choice of this broad measure of the money supply was based on the view that it possessed three key characteristics. First, it was thought that it gave a good indication of future developments in inflation. Its empirical behaviour in the early 1970s, in particular, had been encouraging. The peak rate of growth of £M3 reached in the fourth quarter of 1973 (27.4% year-on-year) bore an uncanny resemblance to the peak rate of inflation (26.9%) reached in August 1975. Second, broad money was related, through its credit counterparts, to other key aspects of government policy. This approach provided a coherent link between fiscal and monetary policy; it emphasised the need to finance a public sector borrowing requirement through sales of government debt to the private sector, and it made clear that foreign exchange intervention by the authorities had an effect on broad money growth. In this way the broad money supply encapsulated in one single measure all of the key dimensions of fiscal, funding and foreign exchange policy. Third, it was thought that broad money had a reasonably close relationship with money GDP. Control of broad money would, therefore, be associated with control of nominal incomes in the economy, the ultimate objective of policy.