Monetary Policy (Hansard, 5 December 1980)

§ Mr. Lawson

The text of the reply sent to the hon. Member on 24 September was as followsOn 7 August you asked four parliamentary questions on monetary policy. I replied by saying that I would write to you. I shall answer the questions in the order in which your questions appeared on the Order Paper. You asked Geoffrey Howe whether he would circulate in the Official Report the occasions since 1960 when the banks have been required to place special deposits with the Bank of England; how long the deposits lasted; and what was the reduction in liquidity in the system as a result. A list of the occasions between 1960 and the end of 1969 when calls for special deposits were made is shown on page 17 of the Bank of England Statistical Abstract No. 1 (1970). A similar list for the period 1970–74 is shown on page 72 of the Bank's Statistical Abstract No. 2 (1975). More recent figures are given in Table 6.4 of the CSO's Financial Statistics (Table 6.2 until November 1979). The impact of special deposits calls on the liquidity of the banking system will depend on how banks adjust their balance sheet structure. However the special deposits made by banks are shown in Tables 9(1) and 9(2) of the Bank of England Statistical Abstract No. 1 (1970), Tables 8.2, 8.3 and 9 of the Bank of England's Statistical Abstract 1975, and Tables 6.16 of the CSO's Financial Statistics for most recent period (Tables 6.3 until November 1978). Your second question asked for the reasons why bank lending to the private sector only responds slowly to changes in the interest rates, as stated in the Green Paper on Monetary Control. There are, no doubt, a number of reasons why bank lending to the private sector appears to respond only slowly to change in interest rates. The following are probably among the more important:

(i) A significant proportion of bank lending to the private sector as on fixed interest-rate terms. An interest rate increase will only affect borrowers when they come to roll forward their loans.
(ii) It takes time and there are costs involved for companies to adjust their operations to changes in their costs, including interest costs.
(iii) Companies may initially believe that the change in interest rates will be quickly reversed.
(iv) Changes in nominal interest rates may both reflect and themselves have an impact on the other factors inluencing the demand for credit, such as output and inflationary expectations. The relationship is therefore not straightforward.
(v) Movements in relative interest rates could be important. If long rates rise relative to short rates, companies may come to rely increasingly on bank borrowing.

You also asked whether the assertions made in the article on monetary policy in Economic Progress Report 123 about the relationship between money and prices are equally valid whatever the intensity of the utilisation of the country's resources of labour and capital. Over a period, money is broadly 'neutral', in the sense that any reduction in the money stock will eventually be reflected largely in the price level. Output and capacity utilisation, on the other hand, are in the long run determined mainly by non-monetary factors. Therefore, the assertions made in the article are equally valid whatever the intensity of the utilisation of the country's resources of labour and capital. However, the timing of effects of changes in the money stock will depend on the initial situation in the economy, including the level of capacity utilisation. Finally, you asked for the growth of domestic credit expansion in each year since 1970 as a percentage of the money stock; how this compares with the growth in the money supply; what was the reason for the difference in each year; and what is the significance of the variation in terms of: (a) the money economy and (b) the real economy. Figures for DCE and changes in the money supply are given in Table 7.3 of CSO's Financial Statistics. Money stock figures are given in Table 7.1 of the same 207W publication. The difference between DCE and changes in sterling M3 is accounted for by the external and foreign currency transactions which may be interpreted approximately as the surplus on balance of payments current account and non-bank private sector capital account taken together (to the extent that it is converted into sterling). This relationship is shown, as far as existing statistical sources allow, in 'Financial Statistics' Tale 7.4, which was introduced in July this year. A persistent discrepancy between DCE and changes in the money supply will only occur if there is a sustained difference between changes in the demand for sterling by the UK (non-bank) private sector (on the one hand) arid in the demand for sterling by other holders (on the other). Whether such a difference exists will depend on the exchange rate policy which is being followed. If the exchange rate is being kept down by the authorities, DCE will tend to be lower than the growth in sterling M3; conversely, if the authorities are intervening to keep the rate up, DCE will outstrip the growth in sterling M3. Where the exchange rate is freely floating one would expect, other things being equal, to see little difference between DCE and the growth in sterling M3, since any divergence between DCE and the underlying growthin the demand for money will be offset by changes in the exchange rate. However despite our policy of allowing the exchange rate to find its own level there has in recent months been a tendency for DCE to outstrip the growth of sterling M3, with continuing net outflows from the non-bank private sector. This is associated, in large measures, with the once-for-all effect of the abolition of exchange controls, which produced a temporary shift in the balance between resident and non-resident demand for sterling While the gap between DCE and the growth in sterling M3 is not absolutely congruent with the effect of removing exchange controls, it was only to be expected that the net result would be a period in which sterling M3 grew rather more slowly than DCE. It is not however the Government's view that DCE should be ignored: indeed, we made it clear o n the Green Paper on monetary control that we intend to monitor DCE as well as the main monetary aggregates. But it is the growth of the money supply that has the closer relationship to the growth of money incomes

	Market vale of owner-occupied housing in Great Britain: End-year	Whole economy gross capital stock	Whole economy net capital stock	Net personal wealth	Value of ordinary shares held by individuals at market prices	Assets owned by manufacturing imlustries
						Gross capital stock	Net capital stock
End-year (at current replacement cost)	End-year (at current replacement cost)
1952	10.1	61.5	35.4	n.a.	n.a.	13.0	7.4
1953	9.7	62.7	36.2	n.a.	n.a.	13.5	7.7
1954	10.0	66.3	38.4	n.a.	n.a.	14.4	8.2
1955	10.7	71.9	41.9	n.a.	n.a.	15.7	9.0
1956	11 8	76.5	44.9	n.a.	n.a.	16.9	9.9
1957	12.3	80.2	47.6	54.8	8.7	18.0	10.8
1958	13.2	82.3	49.3	61.5	11.8	18.6	11.3
1959	14.0	84.3	50.9	70.6	18.0	191	11.7
1960	16.1	88.9	54.1	72.0	16.7	20.3	12.5
1961	18.0	94.6	58.2	77.4	18.0	21.8	13.6
1962	19.9	100.7	62.5	85.6	17.2	23.0	14.5
1963	23.6	107.0	66.9	92.4	19.1	24.3	15.3
1964	26.5	113.9	71.8	94.9	15.7	26.0	16.4
1965	28.7	122.4	77.7	102.8	16.0	28.1	17.7
1966	31.5	130.0	83.1	112.3	17.9	29.8	18.8
1967	34.3	138.4	89.1	123.6	22.1	31.3	19.7
1968	38.2	150.5	97.6	188.1	28.3	33.6	21.2
1969	41.0	165.9	108.1	140.5	24.2	37.0	23.4
1970	45.8	188.1	122.9	147.0	22.5	42.3	26.8
1971	55.3	216.2	141.5	174.8	29.8	47.9	30.4
1972	85.8	257.8	169.1	212.7	36.3	54.6	34.5
1973	107.2	327.2	215.7	246.2	25.5	66.7	42.1
1974	111.3	417.9	275.7	243.7	13.0	83.8	52.7
1975	121.2	505.3	332.6	286.9	24.0	101.3	63.2
1976	135.1	582.1	381.8	312.3	22.0	119.1	73.7
1977	148.4	663.1	432.4	365.1	30.4	137.5	84.5
1978	187.4	775.5	504.6	430.2	31.9	158.4	96.9
1979	252.2	932.6	605.4	n.a.	n.a.	186.8	113.8

208W

and prices. DCE provides one (but not the only) measure of credit, but to the extent that the excess goes to foreign holders, inflationary pressures at home are reduced."