The Quantity Theory of Money: A New Restatement


  • The overwhelming majority of economists were wrong in their forecasts about the consequences of the Covid-19 pandemic. They believed that it would result in years of falling inflation or even deflation. Instead, 2022 saw the highest inflation for 40 years in several leading economies.

  • In early 2022, Professor Jason Furman, an influential American economist who advised President Obama, lamented the economics profession’s ‘dismal performance’ and ‘collective failure’.

  • However, from an early stage those few economists who tracked a broadly defined measure of money – including the author of this book – correctly forecast the inflation flare-up. They noticed that in spring and summer a money supply explosion was under way in the US, the euro zone and the UK, and indeed in many other jurisdictions.

  • This book argues that the high inflation numbers of 2022 and early 2023 were caused by excessive growth of the quantity of money. The Covid-related inflation episode was yet another illustration of Milton Friedman’s adage that ‘inflation is always and everywhere a monetary phenomenon’.

  • Leading central banks – the Federal Reserve in the US, the European Central Bank in the euro zone, the Bank of England in the UK, and so on – organised the central bank asset purchases of long-dated securities from non-banks (or ‘quantitative easing’) which led to 2020’s money explosion. They were therefore responsible for annual inflation peaking, after a fairly standard lag of about two years, at close to or above 10% in many countries.

  • Different versions of the quantity theory of money – and of its modern incarnation as ‘monetarism’ – need to be distinguished. Meanwhile the equation of exchange (MV = PT) suffers from ambiguity and imprecision.

  • This study emphasises the importance of a broadly defined money aggregate in the determination of nominal national income and wealth. It differs from Chicago School monetarism by denying that the monetary base and narrow money play a major causative role in a modern economy.

  • The proportionality postulate – which nowadays is the claim of similar changes in equilibrium of broad money and nominal national income – is a reasonable approximation to the facts, although it needs to be qualified by ‘financialisation’. This is the tendency for financial transactions (and hence the need for money) to grow faster than income as economies progress.

  • In practice and for much of the time, most economies suffer from a degree of ‘monetary disequilibrium’. (See chapters 4 and 5 for an explanation of this term.)

  • Broad money may change substantially, and disruptively, in a particular period, shattering a previous monetary equilibrium. (The Covid-related events of 2020 were a good example.) If the quantity of money is then given for the next few periods, national income and wealth – along with the prices of goods and services, and of assets – have to change to restore equilibrium. Excess or deficient money causes these adjustments.

  • The most important assets in the adjustment processes are corporate equity, housing and other forms of property, which have varying income over time. Bonds are relatively unimportant, even though they are the focus of discussion in macroeconomics textbooks.

  • Indeed, many textbooks – notably the Samuelson textbook, which first appeared in 1948 with a condensation of Keynes’s 1936 General Theory – adopt Keynes’s liquidity preference theory of ‘the rate of interest’ (that is, a bond yield). They give this theory (and the associated ‘IS function’) an inappropriately large status in national income determination.

  • In macroeconomic analysis the proportionality postulate can be assumed to apply to variable-income assets in equilibrium.

  • Interest-rate-only macroeconomics – particularly as exemplified in the three-equation version of New Keynesianism – has ostracised money from central bank research in the twenty-first century. This kind of money-less macroeconomics is the key intellectual mistake behind the ‘dismal performance’ and ‘collective failure’ identified by Furman.


This book began as the intended first chapter of another book – to be called Money and Inflation at the Time of Covid – which Edward Elgar Publishing plans to bring out in 2025. In the original version of about 23,000 words it was distributed in December 2023 as an attachment to the monthly e-mail I write for the Institute of International Monetary Research ( Happily, Tom Clougherty, just appointed as Executive Director of the Institute of Economic Affairs, saw the e-mail and liked the attachment. He suggested that the chapter might become a short book in its own right, under IEA covers. I leapt at the idea. Within a few weeks, the 23,000 words had doubled and evolved into 11 chapters, and here is the result. I think it is coherent as a book, but readers can make up their own minds.

The IEA’s intervention was appropriate for two reasons. First, in spring 2020 it had welcomed a contribution – entitled Inflation: The Next Threat? – on the then money explosion and the implied inflation risks from my colleague, Juan Castañeda, and me. Our worries in that publication have been amply vindicated in practice, and it is appropriate for the IEA to support a somewhat more analytical sequel. Second, in 2005 the IEA published my study of Money and Asset Prices in Boom and Bust, which reflected particularly my experiences – as a business economist and financial commentator – of the UK’s two big boom–bust cycles in the 1970s and 1980s, and the calmer period which followed. The current work resumes the argument of Money and ­Asset Prices in Boom and Bust. Although I hark back to the beginnings of the quantity theory of money, this work is obviously a response to very recent events. The underlying theoretical framework is nevertheless the same in The Quantity Theory of Money: A New Restatement as in Money and Asset Prices in Boom and Bust. I hope it is organised and presented better.


I have several debts. First, the IEA has welcomed my research for many years, and – as I say in the introduction – I must express my gratitude to Tom Clougherty and Syed Kamall, who was the IEA’s Editorial Director in 2020. Kristian Niemietz, now the IEA’s Editorial Director and Head of Political Economy, has taken this publication forward and ‘thank you’. Samuel Demeulemeester and John Greenwood read an early draft, and offered very helpful and detailed comments.

It will be clear from the book itself that I am no fan of most contemporary macroeconomists. All the same, the late Victoria Chick, Charles Goodhart and David Laidler have been on similar wavelengths to me throughout my career, even if not on exactly the same waveband. I have much valued their interest and support. Steve Hanke of Johns Hopkins University has become an outstanding proponent of broad-money monetarism, and I admire and thank him for battling with the reprobates who dominate the American profession.

Keynes’s biographer, Lord Skidelsky, in his 2018 book Government and Money gave me the label and brand of ‘Keynesian monetarist’, which I like. I am indebted to him for that perhaps accidental exercise in promotion.

Finally, my colleagues at the Institute of International Monetary Research – especially Juan Castañeda and John Petley – have tolerated me in the last decade or so, and again ‘thank you’. Fellow members of the IEA’s Shadow Monetary Policy Committee have also been very easy-­going and nice to me, even when I have been too much of a prima donna.

In preparing the book for publication, I am indebted to Jon Wainwright of T&T Productions for his help with reading and correcting an often awkward proof.

None of the above are responsible for the mistakes and infelicities which remain in The Quantity Theory of Money: A New Restatement. The restatement is in many ways a rather personal contribution, and I am very much to blame for its errors.

(I have a small style point. The first person is used in this preface and the introduction, but in the following chapters I refer to myself in the third person as ‘the author’. The point may seem pedantic, but something has to be done for consistency.)


Economists in the mass – as a profession, no less – have not covered themselves in glory in the early 2020s. Like everyone, they were caught off guard by the Covid pandemic. But, unlike most people in other walks of life, they blundered in their reaction to it. An almost unanimous consensus was that Covid-19 would lead to years of disinflation and perhaps even of deflation. Instead, in 2022 inflation reached the highest levels for 40 years in the UK, as in other leading nations.

Economists in the US had a conspicuously bad record in their mis-forecasting of inflation. In January 2022, an influential figure in American policymaking, Professor ­Jason Furman of Harvard University, contributed a column to the Project Syndicate website, under the title, ‘Why did almost nobody see inflation coming?’ As he pointed out, in 2020 none of the Federal Open Market Committee’s 18 members expected inflation above 2.5% in 2021. In fact, consumer prices rose by 7% in the year to December 2021. Furman lamented economists’ ‘dismal performance’ and ‘collective failure’.1

But in the UK at least there were exceptions to Furman’s ‘collective failure’. I am pleased to say that they included me, the author of this short book.2 Right from the start, in late March and April 2020, my assessment was that the astonishing money explosion then under way would have inflationary consequences. The first result would be too much money chasing too few assets, so that the prices of shares and houses would be buoyant in late 2020 and 2021; the second would be too much money chasing too few goods and services. Consumer inflation might reach double digits at an annual rate per cent in 2022 or 2023. I was particularly concerned about the inflation prospect in the US, although I did not neglect the UK and worried about the euro zone as well.3 On 30 March 2020 I sent out a special e-mail to subscribers of the Institute of International Monetary Research monthly note. It ended with the sentence:

Assuming that money growth does reach the 15 per cent to 20 per cent band [in the US] for a few months, the message from history is that the annual increase in consumer prices will climb towards the 5 per cent – 10 per cent area and could go higher.

(The peak rate of annual money growth in fact came in June 2020, at over 25%. The full e-mail is reproduced in an appendix to chapter 8 below.) On 23 April 2020 the Wall Street Journal published an article by me with the headline warning ‘Get ready for the return of inflation’. These two pieces were only a modest fraction of my output at the time (see, for example, Congdon 2020).

I collaborated closely with my colleague, Juan Casta­ñeda, in the preparation of a pamphlet for the Institute of Economic Affairs called Inflation: The Next Threat? (Castañeda and Congdon 2020).4 To quote from the synopsis:

The extremely high growth rates of money [now being observed] will instigate an inflationary boom … Central banks seem heedless of the inflation risks inherent in monetary financing of the growing government deficits.

The Institute of Economic Affairs is to be thanked for publishing our work very quickly, in June 2020. The then Editorial Director, Syed Kamall (now Lord Kamall), knew that we represented a minority view, but he backed us to the hilt. We are most grateful to him for his support. As noted in the acknowledgements, I must also thank most warmly Tom Clougherty, the IEA’s current Director, for suggesting to me that this book – initially intended as the first chapter of a longer study on Money and Inflation at the Time of Covid – might make a worthwhile IEA publication.5

Focus on the transmission mechanism

The purpose of the current work is mostly to offer an analytical framework – a theory, if you wish – which explains why I was right in spring 2020 to predict a significant upturn in inflation. Another part of the agenda is to identify (what I regard as) a serious misperception in the majority thinking which led to economists’ ‘dismal performance’. My first step is to recall Milton Friedman’s 1956 restatement of the quantity theory of money, as it is now almost seven decades later and another restatement is surely needed.

My focus is different from Friedman’s. It is on the theory of the transmission mechanism from money to the economy, which in applied contexts usually means from changes in the rate of money growth to a range of macroeconomic outcomes. The outcomes include – crucially – the inflation rate. By contrast, in 1956 Friedman concentrated on the properties of the money demand function. In explaining how money and the economy interact, I highlight the importance of an all-inclusive, broadly defined measure of money. Friedman would have sympathised with my approach, but he was never as fully committed to broad money as I am in this publication and have been throughout my career. Chapter 10 contains more detail on the differences between Friedman’s position and the current restatement of the quantity theory.6

Chapters 5 and 6 are the vital ones in setting out the transmission mechanism; they should help in understanding how easy it was in spring 2020 to forecast the inflation flare-up which ensued over the next two to three years.

Main propositions of the restated quantity theory of money

  1. Monetary equilibrium is established when non-bank private sector agents’ demand to hold all money balances (i.e. broad money) is equal to the quantity of money created by the banking system and its customers.

  2. When monetary equilibrium holds, the nominal levels of national income and wealth are at the levels desired by money-holding agents, and in that sense national income and wealth are determined.

  3. Transactions are many times higher in value in a modern economy than national output. But – no matter how enormous their value – transactions between non-bank, money-holding agents cannot change an all-inclusive measure of the quantity of money. If monetary equilibrium does not hold and the quantity of money is given, national income and wealth must adjust to restore equilibrium.

  4. Changes in the value of variable-income assets (equities, real estate) – often due to changes in the quantity of money – are a central feature of the transmission mechanism. The Keynesian claim that the transmission mechanism involves only changes in the value of bonds (i.e. in ‘the rate of interest’), as in ‘the IS function’ of the textbooks, is a serious misunderstanding.

  5. If certain assumptions are met, changes in the quantity of money and nominal national income are equi-­proportionate in equilibrium (‘the proportionality postulate’). In practice, the required assumptions are rarely met in full and ‘monetary disequilibrium’ often prevails. But enough stability is to be found in agents’ money-holding behaviour, particularly in that of households, that changes in velocity (the inverse of the ratio of money to national income) are small over periods of several years. More exactly, they are small compared with changes in either broad money or national income.

  6. In equilibrium, the proportionality postulate applies to variable-income assets, as well as to the goods and services which constitute national output.

  7. The quantity of money is determined by the extension of credit to the state and the non-bank private sector by the banking system; it is not usefully interpreted as a simple multiple of cash issued by the central bank or of capital invested in banks. The banking system consists of both profit-motivated commercial banks and a central bank. The central bank has the unique prerogative of issuing legal-tender; its objectives are set out in legislation, which usually include the aim of price stability (or at any rate low inflation).

When shown this box, many economists may wonder what the fuss is all about. Don’t the propositions amount to little more than organised common sense? Why has there been so much squabbling and rhetoric about these matters? Further, to the handful of economists who have bothered to read Keynes – as opposed to the hordes who call themselves ‘Keynesians’ – the contents of the box may be more than a little ironic. Monetarists and Keynesians are usually stereotyped as opposites or even antagonists. But the few authentic Keynesians, those who have read all his principal works and not just the General Theory, might contend that the box does no more than recall key themes in the 1930 Treatise on Money.

I would not resist this interpretation; Keynes – particularly the Keynes of the Treatise, and of the 1923 Tract on Monetary Reform and the vast body of still readable journalism – is one of my intellectual heroes. In his 2018 book on Government and Money, Keynes’s biographer, Robert Skidelsky, labelled me a ‘Keynesian monetarist’ (Skidelsky 2018: 279–81). This may have bewildered people, as it seemed to be an oxymoron. I took it as a compliment. It does in fact locate me well in the much-disputed territories of macroeconomics and monetary theory. But I dislike intensely one salient theme in the General Theory, for reasons which will soon become apparent.

Skidelsky was kind enough to say in his book that my work was ‘important’, although he qualified this by describing me as ‘lonely’ and ‘an outlier’. I regard my analytical framework as banal and straightforward, and do not believe it should be controversial. Nevertheless, the events of 2020 showed that Skidelsky was correct to suggest that I was an outlier. The framework implies – it very clearly and obviously implies – that a marked acceleration in the growth of broad money will result in a marked acceleration in inflation. But, to repeat, in spring 2020 – if close colleagues are excluded – I was almost in a minority of one in arguing that money growth in the teens or above per cent risked inflation in the teens per cent. Some attention was paid to my warnings, but not much.7

Frankly, the economics profession was hopeless in its initial assessment of the Covid-19 shock and the appropriate policy answers. The mistake was so bad that almost all economists were wrong about a major shift in the direction of change in the aggregate price level, less than 18 months before that shift occurred. In my view, the ­trouble stemmed, above all, from:

  • neglect of money growth trends in contemporary macroeconomic analysis, particularly in the supposed powerhouses of such analysis in the research departments of central banks, and

  • imprecision, ambiguity and confusion in past statements of the quantity theory of money.

This book argues that the behaviour of money growth must be restored to a strategic position in policy-­oriented macroeconomic analysis; it also tries to provide a statement of the quantity theory which is precise and rigorous, and therefore lends itself to successful forecasts of inflation.

When I use the phrase ‘contemporary macroeconomic analysis’, to which of its aspects am I most unsympathetic? This introduction may serve as an appetiser to the main course of the book’s argument by emphasising two areas of particular disagreement and tension. One of these – which may come as a surprise – is with ­other economists who sometimes (or even always) say they are monetarists, adherents of the quantity ­theory or whatever; the other is with the pivotal position of the ­investment-saving (IS) function in textbook Keynesianism and a modish extension of textbook Keynesianism known as New Keynesianism.

Different ‘monetarisms’

The main claims of this book rest on the ability of a broadly defined money aggregate to determine other macroeconomic variables. If this is monetarism, it is very much ‘broad-money monetarism’. I am unenthusiastic about two alternative approaches, which might be called ‘­monetary-base monetarism’ and ‘narrow-money monetarism’. The subject is so large that concision risks misrepresentation, but space is limited, and I must be brief. The essence of these alternatives seems to me captured in the following descriptions:

Monetary-base monetarism. This line of thought has two main versions. The first is that the monetary base by itself – without invoking any other money balances – is the key measure of money in the determination of national expenditure and income; the second is that the link between the monetary base and a deposit-dominated money aggregate is so mechanical and certain that their rates of change are similar (or even identical), and – via the influences of the base on the wider money aggregate and of the wider aggregate on the economy – the base is again the ultimate determinant of national expenditure and income.8 (The monetary base is defined below in chapter 2; it consists of the monetary liabilities of the central bank.)

Narrow-money monetarism. Here the idea is that a narrowly defined measure of money – again by itself – determines national expenditure and income. By implication, the tracking of a narrow aggregate such as M1 is sufficient for the analyst to forecast inflation. Further, if exponents of the quantity theory are asked for evidence of stable ­money-holding preferences, they think M1 is the appropriate aggregate in econometric investigation. (Narrow money is also defined in chapter 2.)

I am antipathetic to much of what these two kinds of monetarism have to say. They have done a lot of damage. When adopted by distinguished and influential economists, they have often led to forecasting mistakes and embarrassment.

When Friedman made his ‘blooper’ on inflation in the 1980s, by forecasting a significant rise which did not ­occur, the blooper arose from his selection of M1 as the most important aggregate in assessing inflation trends;9 when Patrick Minford in the late 1980s wrongly quarrelled with me about whether the UK’s Lawson boom would prove inflationary, it was his attachment to the M0 notion of the monetary base which was responsible;10 when four fellows of the Hoover Institution signed an Open Letter to Ben Bernanke in 2010, with its misjudged warning that the Fed’s asset purchases would cause ‘currency debasement’, they were anxious about the very rapid growth of the monetary base consequent on those asset purchases.11 To reiterate, I do not care for either monetary-base monetarism or ­narrow-money monetarism. Moreover, I have no truck with appeals to ‘the aggregates’ in the plural, since these in my view are confessions of muddle or even ignorance. Analysis in this area of economics should relate to a broadly defined measure of money, full stop. Admittedly, there is a so-called ‘boundary problem’ in defining it.12

IS-LM – or IS vs. LM?

What is my objection to the IS function? Non-economist readers may be puzzled by the phrase. The IS function originated in a 1937 review article of Keynes’s General Theory. It was written by Sir John Hicks, later awarded the Nobel Prize and undoubtedly one of Britain’s greatest economists. (He is given a starring role in chapter 5 below.) The General Theory may have been a revolutionary work, but perhaps for this very reason it was difficult to follow and understand. Not the least of its perplexities was that ‘the rate of interest’ (meaning a bond yield) was active in two ostensibly separate processes of national income determination. The rate of interest both equilibrated the demand to hold money with the supply, where the demand to hold money was related to national income, and it determined investment, where national income was a multiple of investment.

Were there two distinct theories of national income determination in the one purported master work? Hicks’s trick was to propose one function (which became ‘the LM [liquidity preference–money supply] function’) for the monetary component of Keynes’s magnum opus, and another function (‘the IS function’) to represent the multiplier story. The two functions could be translated into equations, thereby becoming a simple simultaneous-­equations model of the economy; they could also be assembled in an IS/LM diagram with two neatly intersecting curves. Keynes sent Hicks a postcard blessing the IS/LM construction. It has subsequently adorned over three generations of macroeconomics textbooks, with one of its attractions being that it is easy to mark in examinations.

But the IS/LM ‘thing’ (Hicks’s later characterisation) depended on the structure of Keynes’s argument in the General Theory, and in one important respect that structure was unrealistic to the point of crankiness.13 In much of the General Theory Keynes restricted the choice between money and assets to a choice between money and bonds.14 Hence an increase in the quantity of money raised the price of bonds, which lowered bond yields and his ‘rate of interest’, which stimulated investment, which further spurred a gain in national expenditure and income that was a multiple of the extra investment. Here was the IS function at work.15

The last paragraph summarises a key strand in the General Theory; its sentences also respect syntax and the recognised meaning of words. However, in my view it is fantastic that this part of the General Theory has been accorded so much attention by three generations of economists. Is this the right way to organise the interpretation of business and financial reality? In the hypothetical world of the General Theory only two assets figure in the analysis, that is, money and bonds; in the real world, agents are balancing money both against goods and services, and an assortment of assets of which equities and real estate are far more important than bonds. As I discuss in chapters 2 to 6 in this book, and particularly in chapters 5 and 6, bonds are a relatively unimportant asset class in a modern economy. Fluctuations in the value of equities and real estate (which I call ‘variable-income assets’) have far greater effects on changes in aggregate demand than fluctuations in the value of bonds (fixed-income assets).

The IS function may have helped Hicks to summarise the complex argument of the General Theory for the purposes of university instruction. But this part of Keynes’s larger thesis was – and remains – about a minor feature of the economy and has little traction in understanding modern business life. Given the trivial position of bonds in the household sector balance sheet (as shown in chapters 4 and 6), the IS function misses at least 90% of the interaction between money and the economy. Indeed, in the extreme conditions of late 2020 and early 2021, when excess money drove large gains in the stock market and house prices, it was probably picking up less than 2% of that interaction. (See pp. 82–87 in chapter 6 for more justification of this statement.)

The analytical logic behind the LM curve may be more elusive than that behind the IS curve, as it involves reasoning in sometimes abstruse areas of monetary economics. Further, if money has to be retained in macroeconomics, that means banks have to be brought into the analysis as well.16 Banks have balance sheets, while some Keynesian economists seem to find balance sheets difficult to read and understand.17 Over time the IS/LM approach has therefore been truncated and simplified into an approach with the IS function only.18 A high proportion of today’s macroeconomists have come to think in terms of an IS function – and only an IS function – when they want to determine aggregate demand and national income. They forget about money, in the sense of ‘the quantity of money’, altogether. In 2020, the year which in the US saw the fastest growth of broadly defined M3 money since World War II, the minutes of the Federal Open Market Committee contained not one reference to any money aggregate.19

Dangers of three-equation New Keynesianism

The airbrushing of money from economic analysis is most evident in the three-equation distillation of New Keynesianism, a body of thought often deemed to be the workhorse of today’s central bank research.20 In this body of thought only one equation determines national expenditure and income, and it is indeed an IS function.21 In qualification, the rate of interest in the three-equation model is not Keynes’s bond yield, but the central bank rate.22 The substitution is intended to enable the three-equation approach to inform real-world decision-taking by central banks, since it is widely agreed that the rate of interest – not the quantity of money – is their main policy instrument. (The monetarists have advocated following the quantity of money as an intermediate target; they have not said that the quantity of money is a policy instrument. However, operations such as asset purchases from or sales to non-banks have a fairly direct, measurable impact on the quantity of money.)23

Despite the exclusion of money and banking from the three-equation framework, Huw Pill, the current chief economist at the Bank of England, has said that this kind of New Keynesianism is ‘canonical’.24 One premise of chapters 5 and 6 of this book is, on the contrary, that three-equation New Keynesianism is worthless if it is intended to throw light on reality. In particular, the omission of money makes it difficult for central banks to calibrate the size of purchases or sales of long-dated assets (that is, ‘quantitative easing’ or ‘quantitative tightening’) when they want to influence the economy by this method. The asset purchases conducted in 2020 and 2021 were much too large in most of the world’s leading economies. But as central banks did not think about the numerical consequences of their asset purchases for the quantity of money, and as they anyhow dismissed the macroeconomic significance of that quantity, they did not appreciate that a major rise in inflation became inevitable because of their actions.

Pill’s apparent canonisation of the three-equation model is picked up and criticised in chapters 6 and 9. As it happens, the evidential basis for the IS function is underwhelming. Early in the twenty-first century Edward Nelson, one of the Federal Reserve’s top economists and an assiduous reader of the academic journals, was well aware of the rise of three-equation New Keynesianism. But he had had a few brushes with the data and proposed that there was an ‘IS puzzle’. New Keynesians might say an IS function was one of their crucial three equations, but in the real world the IS function was a bit of a sphinx; it did not have the form or the properties it was supposed to have. A notable contribution was made by Charles Goodhart and Boris Hofmann in a February 2005 article, on ‘The IS curve and the transmission of monetary policy: is there a puzzle?’, in the Applied Economics journal (Goodhart and Hofmann 2005). Like so many others, they found that work on reduced-form IS functions was unrewarding. Their best-fitting relationships usually had no explanatory power, but – when they did – all too often the coefficients on the interest rate term were wrongly signed or insignificant. To find better relationships, they added explanatory variables such as property prices and – intriguingly – a monetary aggregate.

Classroom gadgets vs. policy-relevant theory

One of the most active researchers on the IS function was Livio Stracca, an economist at the European Central Bank. In Stracca (2010), he wondered whether the travails of the IS function arose because too much attention had been paid to possibly perverse and misleading results for a limited number of countries. (He may have been thinking of the US and the UK in particular, as these tend to attract most attention from English-speaking economists, for obvious reasons.) He therefore assessed ‘data from 22 OECD countries over 40 years’. His verdict was damning (Stracca 2010):

I find little evidence in favour of the traditional specification [of the IS curve] where the real interest rate enters with a negative sign due to intertemporal substitution: on the contrary, it is typically either insignificant or wrongly signed. Overall, I conclude that the New Keynesian IS curve, at least in its most common formulations, is not structural and is overwhelmingly rejected by the data.

The literature on the IS function is small, but enough work has been done to establish a definite conclusion: convincing relationships between the levels of interest rates and nominal GDP are hard to find, while those between changes in the two variables are yet more elusive. If the IS function is a vital element in a model viewed as fundamental, even canonical, in central bank research, something has gone badly wrong.

Moreover, the elusiveness of the relationship between interest rates and aggregate demand is hardly new. Friedman’s long-time collaborator, Anna Schwartz (1987: 175), once offered a generalisation from her many years of research. Speaking at an academic conference in the UK in 1969, she said:

The correlations between the level or rates of change in interest rates, on the one hand, and rates of change in nominal income, prices and output, on the other, are considerably worse than those between rates of change in the quantity of money and these magnitudes.

Of course, the structure of economies does change over the decades, but – when I tried to disprove Schwartz’s generalisation by looking at the US data about 50 years later – the data refused to comply. The Schwartz generalisation remains valid (Congdon 2021a).

This is not to dispute the potential value of the three-equation approach – like IS/LM – as a classroom gadget.25 But, when economists leave the classroom and assume positions of significant policymaking power, such gadgets may not be much help. If non-economists want to understand why the economics profession has made a hash of the early 2020s, it is – in my view – the veneration of the IS function and the canonisation of three-equation New Keynesianism which deserve much of the blame. ­Interest-rate-only macroeconomics has become dominant in central bank practice, and expelled the quantity of money from research and analysis. Here is the main source of the intellectual failure behind, in Furman’s words, the ‘dismal performance’ of economists in the early 2020s.

I admire the bulk of Keynes’s contribution to macroeconomic theory, but in my view, he used several chapters of the General Theory – specifically, chapters 13–18 – to launch a misguided marketing exercise for the liquidity preference theory of the rate of interest. The IS curve, a by-product of that theory, was later given more prominence in Keynesian textbooks than it merited. This was a wrong turning. One ambition of the Treatise on Money was to develop a theory of the determination of the value of all non-liquid assets, including securities other than bonds.26 By contrast, a big chunk of the General Theory was preoccupied with an unimportant issue, the balance in portfolios between money and bonds. Curiously, and paradoxically, the Treatise in this respect – as in others – had greater generality than the more famous General Theory.27

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About the Author

Tim Congdon is an economist and businessman. For almost 50 years, he has been a consistent advocate of free markets and sound money in the UK policy debate. One of his themes is that banking and money growth have powerful influences on macroeconomic outcomes. He is currently chair of the Institute of International Monetary Research, which he founded in 2014. The Institute is based at the University of Buckingham, where he is a professor of economics.

He was a member of the Treasury Panel of Independent Forecasters (the so-called ‘wise persons’) between 1992 and 1997, which advised the Chancellor of the Exchequer in a successful period for UK economic policy. He has been an advocate of money targeting to control inflation (and deflation) since his first job as an economic journalist on The Times between 1973 and 1976. He worked in the City of London from 1976 to 2005, where he explained the implications of macroeconomic trends for securities prices and asset allocation. He set up the influential consultancy, Lombard Street Research (now TS Lombard), in 1989.


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  1. Few American economists are closer to economy policymaking than Furman, who was chairman of President Obama’s Council of Economic Advisers from August 2013 to January 2017. At the time of writing (March 2024), he is the Aetna Professor of the Practice of Economic Policy jointly at Harvard Kennedy School and the Department of Economics at Harvard University.
  2. In the US the first notable economist to forecast more inflation was Steve Hanke at Johns Hopkins University. His close colleague, John Greenwood of International Monetary Monitor, contributed to a joint effort on this front. Greenwood and Hanke are kindred spirits, and we often work together, but their inflation warnings in this episode were a bit later than those from Castañeda and myself. Hanke’s position in the debate was noticed by ­Jennifer Burns in her recent biography of Friedman (Burns 2023: 471).
  3. Congdon (2023a) covered the UK and included sections – written by me in April 2020 – warning about double-digit inflation. The euro zone is one of the six jurisdictions which have money trends monitored by the Institute of International Monetary Research in its regular monthly e-mails to subscribers.
  4. I set up the Institute of International Monetary Research in 2014 and was its first Director. It is located at the University of Buckingham in England, where it helps in the post-graduate teaching of economics. Castañeda was appointed as the second Director in 2016, when I became the Institute’s Chair.
  5. This book is somewhat longer than the proposed first chapter of the book, Money and Inflation at the Time of Covid, but is much the same in content and argument. Money and Inflation at the Time of Covid is to be a collection of my writings in the early 2020s, which will be published by Edward Elgar Publishing in 2025.
  6. My position is also different from that of the Chicago School, of which Friedman was the most well-known member.
  7. For example, Martin Wolf – in his Financial Times column on 20 May 2020 headed ‘Why inflation might follow the pandemic’ – referred to me, although keeping his distance. In his words: “If one is a monetarist, like Tim Congdon, the combination of constrained output with rapid monetary growth forecasts a jump in inflation. But it is possible that the pandemic has lowered the velocity of circulation: people may hold this money, not spend it. But one cannot be certain. I will not forget the almost universally unexpected surge in inflation in the 1970s. This could happen again.”
  8. I have written a critique of the claim that the monetary base by itself determines spending and inflation (Congdon 2023b).
  9. For Friedman’s mistake on inflation, see Barnett (2012: 107–11). ‘Blooper’ is Friedman’s own word. According to Jennifer Burns (2023: 441) in her Friedman biography, Friedman said to a journalist about his mistake, ‘I was wrong, absolutely wrong. And I have no good explanation as to why I was wrong.’ If he did say this, it was disturbing, to say the least. See the discussion in chapter 10.
  10. The disagreement between Minford and myself was discussed in Congdon (1992: 126–28, 226–27). Minford had been influenced by Eugene Fama, a Nobel laureate who has taught at the University of Chicago for virtually all of his academic career. My views on Fama’s monetary economics are given in chapter 5.
  11. For the Open Letter to Ben Bernanke, see
    ch/open-letter-ben-bernanke. The forecast of rising inflation was completely wrong. In a 2014 column in the New York Times, Paul Krugman called the Open Letter ‘infamous’. See ‘Knaves, fools and Quantitative Easing’, New York Times, 2 October 2014.
  12. Should broad money include only bank liabilities or liquid assets issued by non-banks? What about foreign currency deposits? For these issues in monetary economics, see Goodhart (2008).
  13. Hicks used the word ‘thing’ in the first sentence of a 1980 paper on ‘IS-LM: an explanation’. The paper was reprinted as chapter 23 of Hicks (1982).
  14. In fact, Keynes did not refer in the General Theory to the so-called direct effects of a change in the quantity of money on the economy. See footnote 1 to chapter 5 for the distinction between direct and indirect effects of changes in the quantity of money, as developed in Blaug (1985). A better sentence than the one in the text might be, ‘In influential chapters of The General Theory Keynes implied that the only category in the economy with an important reaction to a change in the quantity of money was the value of a bond.’ Rather obviously, that was not – and is not – right.
  15. Unhappily, according to Keynes, circumstances could be imagined (of ‘virtually absolute liquidity preference’, in his words) where bond prices were already so high that investors had to expect the next major move in prices would be downwards (see Keynes 1973: 207). An increase in the quantity of money could therefore not raise bond prices, lower the rate of interest and stimulate the economy. Monetary policy could be condemned to ineffectiveness, justifying Keynes’s advocacy of public works as a valid means of combating depression. It was this claim of monetary policy ineffectiveness which appealed to many left-leaning economists in the 1940s, 50s and 60s (when Soviet communism seemed to offer an alternative to market capitalism), and curiously still does so today (even though Soviet communism has been thoroughly discredited). They wanted monetary policy sidelined, so that economic policy could become dominated by fiscal policy (and higher government spending) and planning (with consequence intervention in private-sector business and finance). For these wider ramifications of Keynes’s musings on ‘absolute liquidity preference’ (and the related ‘liquidity trap’ idea found in Keynesian textbooks), see, for example, Skousen (1992: 9–34).
  16. Bank deposits are the dominant kind of money nowadays.
  17. Romer (2000: 162) complained about ‘the confusing and painful analysis of how the banking system “creates” money.’
  18. Romer (2000) illustrates the point.
  19. In the US the Federal Reserve stopped publishing an M3 series in 2006. However, an independent consultancy, Shadow Government Statistics, continues to estimate M3 numbers from publicly available information, much of it from the Fed. I am grateful to Shadow Government Statistics for the data.
  20. The word ‘workhorse’ – to describe the position of three-equation New Keynesianism in central bank research – is used on the cover of Galí (2008).
  21. The ostracising of money – in the sense of the quantity of money – from macroeconomics has occurred particularly in the twenty-first century, with a key influence being the version of the three-equation New Keynesian model set out in the much-cited article, Clarida et al. (1999).
  22. The use of the central bank rate in the IS function raises many questions. In my view the central bank rate equilibrates the demand for central bank credit with its supply, and it is set by transactions between the central bank and commercial banks. This is very different from the bond yield in Keynes’s liquidity preference theory, which is set mostly by non-bank investors in the bond market, and brings together their demand to hold money with the quantity of money in existence (Congdon 2018).
  23. The topic is covered in essay 4 in Congdon (2011). See, particularly, pp. 80–81 on different types of open market operation.
  24. Pill (2022a) used the word ‘canonical’ more than once in his approval of three-equation New Keynesianism.
  25. The phrase ‘classroom gadget’ to describe the IS/LM ‘thing’ appears in the concluding section of Hicks’s 1980 paper ‘IS-LM: an explanation’ (Hicks 1982).
  26. The prefaces to the foreign editions of Keynes’s Treatise contained the following statement (Keynes 1971: xxvii):
    My central thesis regarding the determination of the price of non-­liquid assets is that, given a) the quantity of inactive deposits offered by the banking system, and b) the degree of the propensity to hoard or state of bearishness, then the price level of non-liquid assets must be fixed at whatever figure is required to equate the quantity of hoards which the public will desire to hold at that price level with the quantity of hoards which the banking system is creating.
    More succinctly, the price level of non-money assets depends on the quantity of money and wealth-holders’ money-holding preferences. Keynes even ventured a remark on house prices. To quote (p. xxvi):
    When a man in a given state of mind is deciding whether to hold bank deposits or house property, his decision depends not only on the degree of his propensity to hoard, but also on the price of house property.
  27. Another illustration is that the Treatise has both a central bank and a commercial banking system, with the central bank issuing base money and the commercial banks bank deposits. By contrast, the General Theory has a consolidated banking system which issues money. One result of the simplification is that the General Theory has no well-developed account of the determination of the quantity of money.

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