Monetary Policy and Public Finance

G. C. Hockley

• Publisher: Routledge
• Year: 2017
• Topic: Business
• eBook ISBN:
  9781351785105
• Subtopic: Business General
• Index: Business

This title, first published in 1970, provides a comprehensive account of the public finance system in Britain. As well as providing a concise outline of the monetary system as a basis for the realistic understanding of public finance, the author also describes the pattern of government expenditure and revenue in the twentieth-century and goes on to give a detailed account of the taxation system up until April 1969. This title will be of interest to students of monetary economics.

Part I

The monetary system

1

The nature of money

But it is pretty to see what money will do.

SAMUEL PEPYS, March 21st, 1667.

Essential properties of money

To make a comprehensive list of all the items which have been used as money at various times and in various places would be tedious. What have the following items used as money in common: cattle, rice, bark-cloth, women, gold, iron, stone and cigarettes?

These and all items used as money have the common intangible property of general acceptability. Within the community concerned, money is accepted because it is confidently believed that it in turn can be passed on for goods and services. The item serving as money in many communities is often scarce, and therefore valuable in its own right, but this is by no means necessary. A look at a £1 note will make this clear. It says: ‘Bank of England. I promise to pay the Bearer on Demand the sum of One Pound. Chief Cashier.’ It is of itself just a piece of printed paper. If you do demand £1, you can have another £1 note with a different number on it, or two pieces of paper each marked ‘ten shillings’, or a handful of coins whose intrinsic value—the cost of the metal—is only a few pence. The note is worth having, not because the paper on which it is printed is valuable or because the printing on the note has intrinsic worth, but because it is generally acceptable in Great Britain. That is, whatever goods or services are desired can be obtained by the exchange of a sufficient number of notes. The ‘Promise to pay’ engraved on the note is a reminder of the origin of banknotes; at one time they were receipts for precious metals deposited with goldsmiths, and it was expected at any time that the note or receipts could be returned and the metal repossessed. It is only in this century that ‘backing’ for notes, in the form of gold or silver, has been effectively done away with for purposes of transactions internal to a country. Banknotes and coins are not the only form of money in a modern society, for example, the majority of transactions are carried out by means of drawings on current accounts with the commercial banks. More will be said later on the types of assets which should be considered as money, and on the factors which determine the quantity of money in the economy.

Money has been described so far in terms of its function as a medium of exchange. The reason why all but the most primitive of societies need a medium of exchange should be self-evident, and is summed up in the phrase, ‘the sheer inconvenience of double coincidence of wants’. That is, the need to find a seller of the item you require who at the same time needs what you have to offer.

Money, by its nature, also acts in some degree as a store of value. If money were like a day-return ticket on a railway, valueless after the day had ended, nobody would keep it. It is because money is expected to have general acceptability and more or less the same purchasing power the day after, and the day after that, that money is held, and this function is described as a store of value. It is unfortunate that the phrase store of value is often taken to mean that the value is constant. What determines the ‘value of money’—that is, the amount of goods and services for which it can be exchanged and the problem of its value over time—will be taken up again in this chapter.

Money usually also acts as a unit of account and as a standard of deferred payments. The unit of account refers to the fact that instead of valuing each and every article and service in terms of all others, it is valued in terms of a common denominator, the medium of exchange. In a similar manner, contracts for future payments are usually made in terms of the medium of exchange, but they can be made in terms of the value of gold, or a foreign currency, or a quantity of goods. It is usual for money to act in both these ways, but is by no means necessary; the guinea today sometimes acts as a unit of account, but it does not circulate as a medium of exchange.

Definitions of money: liquid assets, primary and secondary money

It was a deliberate choice not to start off with a definition of money in our society. This seemingly simple question does not admit of a simple answer. A commonly quoted definition tells us that money is ‘anything generally accepted in exchange for goods and services and for settlement of a debt’. This definition, while it is useful, needs further clarification.

The following distinctions will be found useful and can be given empirical content. The first, between money and liquid assets, is based on the function performed by the asset in question. Money on this definition is used for assets that act both as a medium of exchange and as a store of value, while liquid assets are used for securities which, while acting as a store of value, do not circulate in exchange. Money is liabilities of the Bank of England—that is, coin and notes and bankers’ deposits (i.e. deposits of commercial banks at the Bank of England), together with deposits by the public at commercial banks. Liquid assets are such items as deposits at the Post Office Savings Bank, trustee savings banks, building societies, local government and hire purchase companies. These differ from money when the moment for payment arises; they must first be turned into money, rather than exchanged directly for commodities. It should be clear from this distinction that what is money at any particular time is a matter of law and of custom. Deposits at the Post Office Savings Bank could be made transferable by cheque, and these deposits would then fall into the category of money, rather than liquid assets.¹

There is no hard-and-fast line that can be drawn that enables us to classify an asset into one category or another. For some purposes, it may be desirable to draw the line more widely than has been done above, for other purposes more narrowly. It is important to realize that the presence of a variety of assets with the characteristics of liquidity will affect the demand for money. The determining characteristics of ‘liquidity’ will be discussed.

Money itself, as defined above, can be split into primary and secondary money. Primary money consists of coin, notes and bankers’ deposits—often simply referred to as ‘cash’. Deposits at commercial banks on both current and deposit accounts are, in this country, what constitutes secondary money.

Money should not be confused with legal tender. Only notes, ‘silver’ coin up to £2, and copper coins up to is are legal tender. In spite of this, the value of payments by cheque are many times the value of payments by cash and notes. The risk of default by banks in Great Britain and most other developed countries is nowadays considered so small, i.e. confidence is so great that transfer of deposits to third persons will be honoured, that deposits are included with notes in the definition of money. In Great Britain also no distinction is usually drawn between current and deposit accounts, because deposit accounts can usually be drawn on with almost as much ease as can current accounts.

Current accounts, sometimes called ‘demand deposits’, are subject to cheque and withdrawal on demand. Deposit accounts, often called ‘time deposits’, formally require seven days’ notice before withdrawal, but in practice a cheque would not be dishonoured if it were covered by a balance in a deposit account. An added reason for not distinguishing between these two accounts is that British banks, unlike, for example, American banks, do not have to observe different reserve ratios for each type of account.

Quantity of money and liquid assets

In 1967, in approximate figures, notes and coins outstanding in the economy amounted to £3,250 million, while deposits at commercial banks were three times as large at some £10,000 million. Post Office securities (Savings Certificates, Premium Bonds, Defence Bonds, Post Office and Trustee Savings accounts) amounted to nearly £8,500 million, Treasury bills to nearly £4,000 million. Short-term deposits with local government authorities amounted to over £1,500 million and shares and deposits with building societies to about £7,000 million.

The list of liquid assets is not intended to be a complete one, e.g. for some purposes, deposits with finance houses, accumulated funds in insurance companies, and others may be included. It can be seen that notes and coin are small in relation to bank deposits, and in their turn liquid assets are bigger than bank deposits.

Liquid assets perform some of the functions of money. They act as a store of value and, while they cannot be used directly as a medium of exchange, they affect the demand for money. Coin and notes, together with current account deposits at banks, do not earn interest, deposit accounts earn a small rate of interest, liquid assets, as a rule, rather more. So a change in interest rates may cause the public to switch some money from bank deposits to liquid assets. Alternatively, the public can switch from liquid assets to money by, for example, demanding repayment of some of their Post Office securities. The amount of money in the economy is thus not necessarily a good guide to the spending power of the public. This latter point was very much the concern of the Radcliffe Committee.

Liquidity

The concept of liquidity has unfortunately been used in a number of ways, and come to mean different things to different people. In this book we shall regard it as: the speed and certainty with which an asset can be turned into money without loss, or into a known amount of money in relation to its face value. Shares in quoted companies, gilt-edged securities and Treasury bills can all be turned quickly into money: just pick up the telephone and call a stockbroker. Equity shares and gilt-edged would not, however, be classified as liquid assets, for the amount of money obtainable by sale on the market is not known in advance, whereas Treasury bills are highly liquid, for they have only to be held to maturity, at most three months, to be paid face value; or, alternatively, they can be discounted straight away at a rate which is known in relation to Bank Rate. If Bank Rate doubled overnight, a most unlikely occurrence, it will still only inflict a very small capital loss on having to discount a bill, whereas it would severely depress gilt-edged prices.

A second distinction between these assets is that equity shares are the liability of various companies, and therefore there is a possibility of default, whereas government securities are, in most countries, deemed to have a negligible risk of default. In a financial panic, it is better to be holding liquid government assets than liquid private assets.

It is evident that assets can be arranged on a scale: at one end completely liquid, i.e. money; at the other end, illiquid—say, an IOU from me to you or a piece of real property. If liquidity, the ability to exchange an asset quickly for a known sum of money, was the only consideration governing the holding of assets, we should expect to find that the yield on securities would increase as the asset became more illiquid, the better yield being necessary to induce the public to hold the more illiquid securities. It is found that securities do, as a ...

Table of contents

• Cover
• Half Title
• Title Page
• Copyright Page
• Table of Contents
• Acknowledgments
• Terminology
• Introduction
• Part I: The monetary system
• Part II: Public finance
• Part III: Policy
• Index