Before I review The Quantity Theory of Money: A New Restatement (PDF) chapter-by-chapter, allow me to put things into context. Tim Congdon is the deepest thinker in this field and one with enormous experience as a banker with real skin in the game. If that weren’t enough, he started his career as an economics journalist at The Times in the 1970s. In short, unlike most economic writing, his book is readable. Following his work at The Times, he founded Lombard Street Research, when I first became acquainted with him. At the time, I was strategizing and trading at Friedberg Mercantile Group, a broker-dealer in Toronto, where I am currently chairman emeritus. He kept me well-supplied with his writings, and I gave them my most careful and anxious attention. Why? Because his forecasts were usually right — and often very contrary to the consensus.
During the Thatcher years, when monetarism was introduced to the United Kingdom, Congdon was at the center of things as a high-profile monetarist and forecaster, and one of the Chancellor of the Exchequer’s “Wise Men.” Finally, it was Congdon’s work, particularly Money in a Free Society — a book which I spent several weeks in Paris studying and corresponding with Congdon on — that incited my transition from a recipient to a supplier of monetary research.
Today, I have the privilege to serve on the Academic Advisory Council of the Institute of International Monetary Research at the University of Buckingham, which Congdon founded in 2009.
In the first half of the book — namely, Chapters 1 through 6 — Congdon lays out his restatement of the quantity theory of money, how he arrived at it, and the related consequences of that restatement. He delineates how changes in the stock of broad money are transmitted through asset prices, the real economy, and the price level.
Perhaps the most important contribution of these chapters is Congdon’s analysis of how changes in the stock of money affect variable-income assets — such as real estate and equities — differently than fixed-income assets (bonds). In Congdon’s view, variable-income assets are the best measure of households’ preferences — who in his terms are the “ultimate wealth-holders” — rather than the fixed-income markets dominated by institutional investors. In fact, when we make the reasonable assumption that the incomes paid on variable-income assets are a constant ratio of GDP, Congdon’s “proportionality postulate” — or the idea that changes in the quantity of money and nominal GDP are equi-proportionate in monetary equilibrium — is clearly a useful tool in explaining how changes in monetary policy are transmitted to those asset prices.
Using empirical data, Congdon goes even further to assert that the relationship between money growth and fixed-income asset yields is dominated by variable-income assets, and contends that Keynes’ development of the problematic liquidity preference theory of the rate of interest influenced Paul Samuelson into bamboozling “three generations of economists into believing that bond yields held the key to understanding macroeconomic instability.” His conclusion rings true in an era dominated by direct central bank manipulation of bond yields. Contrary to the view of every “Dick, Tom, and Harry,” monetary policy is not about interest rates; rather, it is about changes in the money supply, broadly measured. And when it comes to the money supply, Congdon is clearly a broad-money, not a narrow-money, monetarist.
Another invaluable nugget in these chapters is Congdon’s exposition on credit counterparts analysis, which explains changes in the money supply as a function of changes in the composition of banks’ assets. Indeed, Congdon is one of the few who recognizes the importance of credit counterparts analysis — and knows how to do it.
In Chapter 7, Congdon analyzes the empirical evidence for his restatement of the quantity theory. Indeed, he finds that the evidence is “overwhelmingly” in favor of the quantity theory. Most interestingly, however, he finds that in the United States and G20 countries, households’ money typically increases slightly faster than households’ income, which violates the proportionality postulate. Here he conjectures that this is because, as economies develop, the frequency of financial transactions (and hence, the need for money) grows more rapidly than incomes. I look forward to Congdon developing this causal mechanism in further articles and books.
In Chapters 8 and 9, Congdon examines the evidence for the quantity theory, particularly during the COVID-19 pandemic, in the United States and United Kingdom, respectively. In my opinion, the most interesting parts of these chapters are his comments on the two countries’ central banks; namely, the fact that both the Federal Reserve and the Bank of England lack a coherent theory of national income determination — or at the very least, neglect the quantity of money.
Notably, he highlights the fact that the Bank of England used large relative price changes (read: not inflation) during the pandemic as an excuse to ignore the absolute price level (read: actual inflation). Congdon concludes that central banks are using the wrong model, the three-equation New-Keynesian Model, which has been popularized over the last three decades and does not include a monetary aggregate. Indeed, central banks have shoved the quantity theory aside.
Chapter 10 is a comparison of Milton Friedman’s quantity theory with the author’s restatement. It makes clear that Congdon’s restatement of the quantity theory is a necessary update for the twenty-first century. Congdon is quite right to alter the quantity theory to accommodate the new — and (in some cases) innovative — ways that money is created in a modern economy, as opposed to 1956, when Friedman published his own restatement.
In Friedman’s view, the supply of money is determined by a “money multiplier” applied to the monetary base, while Congdon allows the money supply to be determined by demand for credit, which comports with the fact that commercial banks create the vast supply of money in modern economies through their lending. He also makes the crucial point that broad measures of money must be used to make the quantity theory work. Indeed, this approach allows for a singular account of the transmission mechanism to be proffered.
In Chapter 11, Congdon wraps up his treatise by recalling Keynes. Did Keynes really hate the quantity theory? Congdon answers that question in the negative. This section is crucial in order to place Congdon’s work — and that of other quantity-theory adherents — in the context of the history of economic thought.
Anyone interested in national income determination, asset markets, real economic activity, or inflation would be well-advised to study The Quantity Theory of Money: A New Restatement carefully. Indeed, this book is required reading for all of my students.
It’s clear from his book that Congdon not only knows more about the quantity theory than most monetarists, but also possesses a deeper understanding of Keynes than most Keynesians.