§ I turn now to recent monetary developments and to monetary policy. A year ago I warned the House that the high growth of output I intended to sustain would entail a growth of money supply which was also high by the standards of previous years.
§ As I predicted, the growth of money supply has indeed been fast by either of the more commonly used conventional meausures, that is, MI, which consists of currency in the hands of the public and 251 current accounts held by private sector residents in United Kingdom banks, or M3, which adds in the corresponding interest-bearing deposit accounts.
§ But it is sometimes overlooked that the movements of these figures can be influenced by considerations which have no general economic significance. For instance, the structural changes in the banking system introduced by the far-reaching reforms of 1971 have increased the rôle of the banks as financial intermediaries at the expense of other institutions whose activities are not included in either the MI or M3 measurements.
§ The rapid growth of certificates of deposit is a major instance of this. After the severe pressures on company liquidity in 1969–70 it was highly desirable that companies should add to their liquid assets. They have done so and they have also found it convenient to hold much of their short-term assets in certificates of deposit with the banks, and this has caused M3 to rise.
§ Moreover, in the conditions of 1972, individuals as well as companies increased their savings and added substantially to their money balances. This is another way of saying that the response of demand to the many measures taken by the Government to expand the economy was slow until the second half of the year, and that money balances were built up rather more than I had expected.
§ Towards the end of 1972, however, when there were clearer signs that real demand was expanding, I thought it right to take action to prevent the liquidity of the banking system from leading to an over-rapid expansion of credit and hence of demand in the months ahead.
§ Short-term interest rates had been allowed to rise sharply during the currency outflow in June, and the banks were subsequently asked to ensure that they had sufficient resources to meet the needs of industry and, as necessary, to make credit less readily available to property companies and for financial transactions.
§ In the autumn there came a change in money market arrangements with the introduction of the more flexible "minimum lending rate", This improved the authorities' techniques for influencing short-term market rates, which are in turn under the new system one of the principal 252 mean of influencing the growth of bank credit.
§ Towards the end of the year, there were two calls for special deposits, totalling 3 per cent. in all, to get the reserve base of the banks and financial houses on a tight rein by sterilising £700 million. This curtailed the ability of the banking system to expand credit.
§ As a result of all these developments money interest rates have risen substantially over the past year. Interest rates are at the heart of monetary control, but in conditions of changing prices it is misleading to look at them solely in nominal terms. The rate of inflation determines the real amount of any particular rate of interest, and therefore the consequences of the rate of interest for the decisions taken by individuals and companies. And the important point is this. Because expectations about the future rate of inflation are a major factor in determining the level of interest rates, the success of counter-inflation policies is crucial to improvements in this sphere as in others.
§ In the coming year, as I shall explain shortly, the public sector borrowing requirement will be high. With real demand expanding, the objective must be to prevent this large borrowing requirement from leading to too rapid a growth of money supply. I therefore intend to take action at once to ensure that, to the maximum extent, the Government's borrowing requirement is met by means which do not increase the money supply.
§ Before I deal with the measures I have in mind, however, I should comment on the development of the Governmnt borrowing requirement in the past year and its probable size in the year ahead, and the implications of this for economic and monetary policy.