Moneterist theory continued from part 1

Investment in plant and machinery will tend to reduce unemployment because after the machinery has been made someone is required to operate it. If money is spent on non-productive infrastructure, like a grand highway leading up to the president’s palace, or building the palace itself, employment will cease as soon as the project is completed. In such cases the money borrowed was not used to increase real production, it merely increased activity.

It is the difference between building an airport near a small town in the desert and building a factory.

It is important to understand the difference between increasing the money supply and increasing expenditure in one area whilst decreasing it in another place. In the latter instance there has been no increase in the total amount of money in the economy.

If the government wants to reduce unemployment by spending money this must be done from the existing supply of money, then inflation cannot occur. But government projects are usually notoriously bad investments. They are one-off indulgences which involve no continuing process of profitable production.

Investment is generally better left to businessmen. The government can assist by freeing the economy from beaurocratic restraints and allowing the entrepreneur to get on with the job.

Governments initiate the cycle of inflation by directing and encouraging the production of useless goods with borrowed money which has to be repaid. When the project is completed only the debt remains; there is no asset only a liability.

 How is the liability paid? By further increasing the money supply, this time not to produce but to repay the debt. The reason why Keynesian policy appeared to work after the Depression but does not work now is that the spending increase then was mostly on productive goods with real value. This led to full employment and inflation was limited because borrowings were repaid out of the profits of production generated.

The fact is that the monetarist approach also worked for a while to reduce inflation without causing noticeable unemployment. Unemployment did exist but nobody cared because everyone else was doing so well. When this became an embarrassment the monetary policy was relaxed (which means that useless government-led production was entered into and borrowings were not repaid) and of course unemployment declined for a moment.

As we have already seen, borrowing for useless production decreased unemployment while the money is being spent but as soon as the non-producing asset has to be repaid more money is released into the economy which now causes inflation.

Ultimately inflation is caused by refusing to acknowledge and therefore to pay your debts. I do not think that simply increasing the money supply on a one-off basis is in itself highly inflationary but real inflation occurs when further increases in the money supply are made necessary to repay the borrowed money and a vicious cycle ensues.

An occasional and judicious increase in the money supply may be useful to induce a shock to stimulate the economy during a depression but as a continuing policy is fraught with danger. It is too often used to put off the evil day of resolving fundamental weaknesses in an economy.

It is probably true (although no politician would dare admit it) that full employment can only be achieved in theory but never in practice. This is because demand for labour never exactly fits the labour available. This is brought about because of constant changes in labour requirements as production techniques change. People trained for one kind of job may be unsuited to the changed technological requirements of ten years later.

Also it must not be forgotten (although never publicly admitted) that some people are simply unemployable, totally uneducated, shiftless, dishonest or of too low an intellect to be employed in a modern economy.

The number of these people is likely to increase - not because more people are becoming dumber - but because the intellectual demands of technology are becoming greater and out of reach of more people. The gap can to some extent be reduced but never entirely closed by appropriate, market-driven educational policies.