Published: September 2019 (10 Min Read)

We have argued for a long time that monetary stimulus is not enough to create a stronger global economy. Yesterday Mario Draghi, President of the European Central Bank, said much the same thing as he announced further monetary stimulus but added, “Almost all the things that you see in Europe, the creation of more than 11 million jobs in a short period of time, the recovery, the sustained growth for several quarters, were by and large produced by our monetary policy. There was very little else… Now it’s high time for the fiscal policy to take charge.”

This may be his way of preparing the ground for Christine Lagarde, who will take over from Draghi at the ECB in November.

Prior to Draghi’s statement a colleague had asked me whether a shift from dependence upon monetary policy towards a greater emphasis upon fiscal policy might increase inflation. It’s a good question.

Since I started working in the City in 1980 Monetarism has been the dominant economic policy.

Simply put Monetarism is a school of economic thought that holds that the money supply is the main determinant of economic activity. In other words, if the money supply is growing, the economy will grow, and if money supply growth is accelerating, so will economic growth.

However, it also argues that if too much money has been put into circulation then inflation will rise too. Hard line monetarists have argued that the substantial volumes of “QE” would cause rampant inflation, but it hasn’t happened.

Why? Possibly because many such commentators seem to have forgotten that it is not just the availability of money which is important but also the degree to which it is used. Since the credit crisis in 2007-9 this measure has been relatively weak. There are many reasons why this may have been so, but it may have related to constraints upon the growth of disposable income, and this is at the root of my colleague’s question.

Would fiscal stimulus release pent-up demand? The answer depends upon how the money is spent. If it targeted those whose standard of living has been most under pressure, then it might.

But I also believe that Monetarism is too narrow a concept within the world we live in.

The constraints upon inflation relate to many other things: an abundance of the supply of goods and services in many sectors driving prices down; a new wave of workers entering the global market and keeping a lid on wage growth; baby boomers going into retirement with their appetites for disposable goods having been partially sated; technology providing efficiencies; and the growth of open borders and free trade between nations. These have broken the wage/price spiral.

The huge amount of debt that households already have is a further constraint upon demand growth, and probably the greatest constraint upon a rise in interest rates too.

To me the greatest risk of inflation would be from the breakdown of free markets, which would then reawaken the wage/price spiral. Something like a price shock in the UK if the Pound is devalued would be a one-off impact.

Some types of fiscal policy might cause an inflationary impact, but I suspect that they would be overwhelmed by the continuing waves of disruption in products and services across free markets.

I believe that inflation and interest rates will remain “lower for longer”. Vivat the free market.