Letter: Monetary policy and an independent central bank

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Sir: Professor Sir Bryan Hopkin (Letters, 7 December) argues convincingly against the idea of setting up an independent central bank.

I write to support his argument with the following simple example. A relaxation of monetary policy (reduction in the rate of interest) will undoubtedly encourage money expenditures and thus increase inflationary pressures; but this will have the side-effect of decreasing any budget deficit, because it will increase tax revenue by increasing the tax bases of money incomes and expenditures and will decrease budgetary expenditures on unemployment relief and on debt interest.

A restrictive fiscal policy (a rise in the rate of tax, or a decrease in government expenditure) may be adopted in order to decrease the budget deficit: but it will also have the side-effect of decreasing money expenditures and thus help to decrease inflationary pressures.

It follows that if the object of policy was to reduce a budget deficit without causing any inflation or deflation of money expenditures, it would be necessary to employ a jointly planned combination of monetary and fiscal controls. One would normally have to combine a strict restrictive fiscal policy with its direct effect on the budget balance with some moderate degree of monetary relaxation to offset the deflationary side-effects of the restrictive fiscal policy. But the greater the side-effect of a restrictive fiscal policy in causing deflation and the smaller the direct effect of an expansionary monetary policy in off-setting this deflation, the greater the relative importance of relaxation of monetary policy in any planned reduction of a Budget deficit.

It is obvious that an efficient policy requires the joint control of inflation and of the budget balance; and for this purpose an overall government authority is needed to devise a policy that takes account of the 'side-effects' of monetary policy on the budget balance and a fiscal policy on the inflation or deflation of money


Yours faithfully,


Little Shelford,Cambridge

9 December