A first stab at explaining the surging money supply

Allister Heath is getting worried over the surging money supply. It's entirely possible that he's right to worry as well. What follows is not *the* way to think about this. It is, rather, *a* way to walk through the basics of the subject.

Think of the equation MV = PQ. Money times the velocity of circulation equals prices times quantity demanded. One way to think of monetary policy is that to try to gee up the economy we try to increase V - we do this by lowering the interest rate. Thus, hopefully, Q increases. Similarly, if P is rising, that is we've got inflation, raise interest rates so as to reduce V and thus stop the rise  in P.

Again, please note that proper monetary economists will have conniption fits at this explanation. We're really trying perhaps too hard to make it simple.

We can also simplify what we mean by "money supply". M in that equation should be thought of as M0 in the national statistics. Notes and coins and central bank reserves sorta stuff. And MV can be thought of as M4, which is M0 plus all the stuff the banking system does, loans and debts and credit and so on. Again, not right but useful as an aide memoire.

Which brings us to the recent unpleasantness. Interest rates were already near or at rock bottom. But we could see that V was plummeting. We were really rather worried about a very deep recession (Q falling) and or deflation (P falling). And the solution there is to create lots more M so that MV doesn't shrink.

Which is one way of describing what QE was and is. The Bank of England makes up some more money and goes and buys stuff with it. Simple because it has made more M0, thus MV is larger than it would be if V fell but there was no increase in M.

All of which is great. But there will come a time when V returns to something like normal. and what we don't want to have is some great overhang of M which when timesed by that now resurgent V leads to massive increases in P - because it won't turn up as Q rising 20% a year, that's for sure. That's where the so far at least unmet predictions of QE causing galloping inflation come from. It presupposes that V returns to normal, of which there's no sign yet. Or, as Heath worries, perhaps there is:

Lilico provides context for this. The 14.7pc rate of increase is a new record for this statistical series, launched in 2009. Looking at an earlier and closely comparable statistical series, the strongest rate of growth in recent history was in 2006, at the height of the pre-crash madness, when the money supply surged by 12.8pc, a jump now widely understood to have been scandalously out of control.

There are other possible explanations for this. But the above is, while a scandalously simplified explanation, a possible one. Our whole aim in doing QE was to protect the economy against that fall in V. The reason it was QE rather than going out and spending the cash is because we wanted to be able to reverse the increase in the money supply (and QE has increased M0 a number of times, it's not just a small percentage increase) if, as and or when, V recovered to more normal levels.

Thus, if V has or is recovering in order to avoid that galloping increase in P we will want to reduce M. That is, reverse QE. The Bank of England will, assuming that this is the right explanation of course, sell the gilts they have and cancel the money they collect from doing so. Or, perhaps, simply not replace maturing gilts as they currently do, thus reducing their stock of gilts over time - this will have the same effect on M as the government will have to issue new gilts to the public to replace those maturing that the Bank holds. 

That is, if the money supply is booming because matters monetary are getting back to normal then the answer is for matters monetary to get back to normal. QE was a response to extraordinary times and if they're leaving the stage then so should QE.