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Monday, July 02, 2007

Inflation: the evidence

If you want to see what monetarists would assert is the fountain of inflation in the UK, here are the M4 money supply figures from the Bank of England, going back to 1963.

The average rise over the whole series is 13.485% per annum; over the last, "prudent" 10 years, 9.99% p.a.

To put it another way, if £1 could have been invested in 1963 at an interest rate that kept pace with this monetary expansion, it would now be worth something like £261. And that's assuming you would have been allowed this interest tax-free, so as to preserve the value of your money.

Contrast that result with the inflation statistics as given by this paper in the House of Commons Library. The figures only go up to 1998, but let's assume purchase prices kept to their approximate target of 2.5% p.a. after that. According to this research, a "basket" of goods and services worth £1 in 1963 would now cost about £15.

Where has the rest of the inflation come out? Asset prices, presumably, or bank profits. Or have the monetarists got it wrong?

One thing's for sure: even after adding net interest at available rates, cash savers have seen an enormous, long-term dilution of their share of the country's circulating money. They would, I estimate, need to receive about 6.7% per annum ABOVE purchase price inflation, to match the money supply increases.

If I've got it wrong, do please show me where the error has occurred.

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