bain_y_howells__monetary_economics__policy_and_its_theoretical_basis

66 MONETARY ECONOMICS
and then substitute 3.17 into 3.14 to show all sources of monetary change.
In making the substitution we have tidied up (notice that ∆Cp cancels
because it enters twice, with opposite signs) and reordered the terms to give
3.18, which is often referred to as the ‘flow of funds identity’.
∆M ≡ PSBR −∆Gp ± ∆ext + ∆Lp
What insights do we gain from the FoF approach? The explicit message
is that changes in the money stock are inextricably linked to lending/borrowing
behaviour. But behind this are three implications. The first of these
is that changes themselves are what matters — one would not use the FoF
approach to analyse a system where stocks dominate everyone’s interest. It
is an implication of the FoF approach that our interest in money supply is
an interest in monetary growth. The second implication is that the monetary
base is of little interest. We shall see in the next section that we can
rewrite the flow of funds identity so as to include changes in the monetary
base, but the fact that the FoF identity is not normally written in that way is
significant. One does not adopt a method of analysis which deliberately
omits variables which one thinks are important. It points to flows as the
important variables and by omitting references to the monetary base it hints
that the authorities might need to find some non-base-orientated way of
influencing these flows. Equally, one does not normally adopt a mode of
analysis which gives a key position to variables of little interest. The third
implication of the FoF analysis, therefore, is that if/when the authorities
become interested in the magnitude of flows, they should pay attention to
lending/borrowing. While the B-M approach creates the impression that
bank lending is reserve (supply) constrained, the FoF creates the impression
that it is (demand) constrained by the non-bank private sector’s desire for
additional credit.
Pause for thought 3.4:
3.5 The two approaches compared
...3.18
According to the FoF approach, what is the relevance to monetary growth of government
debt sales to the non-bank private sector?
While the B-M and FoF approaches are different ways of analysing the
quantity of monetary assets, both consist of rearranging identities at least
one of which — the money stock and its components — is common to both.