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Why monetary theory & practice is flawed

In a previous interview with Hector McNeill, the leading international developer of the Real Incomes Approach to economics and also referred to as RIO-Real Incomes Objective, he described an outline of Price Performance Fiscal Policy as a way to increase productivity and eliminate inflation.

In this follow up interview Hector McNeill ventures into the realms of monetary theory to explain why it is flawed in the light of findings set out in his forthcoming book "The Economic Consequences of The Bank of England: 1975-2025".

Nevit Turk, Senior Economics Correspondent, Agence Presse Européenne, Paris

Hector McNeill is Director of the Real Incomes Objective (RIO) Development Programme at SEEL-Systems Engineering Economics Lab the Innovation Division of the George Boole Foundation Ltd.

A graduate of both Cambridge and Stanford Universities he read agriculture, economics and systems engineering.

He initiated the development of the Real Incomes Approach to economics as a distinct theory and applied approach to economics in 1975 when he realized that Keynesian and monetarism could not tackle inflation or stagflation without imposing significant prejudice on the electorate.

RIO is designed to close the operational gaps in Keynesian and monetarist policies. The RIO alternative is the only current policy proposition able to eliminate inflation.

Hector coordinates the Strategic Decision Analysis Group (SDAG) and is Editor of this year's British Strategic Review.

Nevit: Good to be with you again. We have received a lot of feedback on our last interview and, if there is time, I would like to put to you some of the questions we have received.

However, this interview will cover monetary theory.

Could you please describe how you arrived at the conclusion that monetary theory is flawed?

Hector: Well, this started out in my undergraduate days when reading the Agricultural Tripos at Cambridge University. Part of the course included the planning of operational farms to increase profits based on a linear planning model designed to orientate the allocation of existing resources more efficiently and to introduce marginal boosts to productivity. Although the Farm Economics Branch at the School of Agriculture cranked out linear programs for farms using a DEC Corp computer and the SIMPLEX linear programming algorithm, we students had to work with a note pad, pen and calculator. We used a method known as the Swedish Method used by the Swedish agricultural extension services. This permitted us to get very close to the computer solutions as we gained experience in applying the method across different farming systems. It was only when I transferred to post graduate economics at the Faculty of Economics that I realized how thorough and useful that training had been. I say this because we all became competent in asking the right questions and could identify ways to improve profits and productivity on the basis of using a simple method and using a note pad, pen and calculator. This approach also meant we totally mastered the logic of the linear program. I need to emphasize that the data we used to improve farm operations was based on sample surveys of farms stratified by size and type of production system with realized productivity for each production line (animal or crop-based) divided into three categories of poor, average and good practice each associated with a menu of associated inputs necessary to attain the output recorded.
The Quantity Theory of Money

The conventional identity elaborated by Irving Fischer in 1911 is as follows:

M.V = P.Y


M is the volume of money;
V is the velocity of circulation;
P is the average price of goods and services;
Y is the quantity of goods and services transacted also referred to as real income.

I realized that the only reason farmers and agricultural supply chains companies and downstream commodity companies would normally raise their prices was as a result of a rise in their input costs. To raise prices without a cost rise risked losing sales and market share.

Therefore, when I was first shown the Quantity Theory of Money (QTM) identity which, in simple terms, states that a rise in money volume in the economy will result in a rise in the prices of goods and services I sensed something there was missing from the identity (see box on right). Based on the QTM identity, it was not possible to identify the mechanism whereby a rise in the money volume would cause competing companies to raise their prices. When I asked lecturers and professors what the mechanism was that caused competing companies to raise their prices, both at the Faculty of Economics at Cambridge and later at the Department of Economics at Stanford, they would all refer to the QTM as if that was the answer. Later, in 1975, I watched a TV interview of Milton Friedman who happened to be asked the same question and to my surprise he could not answer the question other than to say "It happens in the long run" which, of course, is not a mechanism.

Nevit: That is surprising. There is that now famous statement by Milton Friedman which I noted down before this interview that, "Inflation is always and everywhere a monetary phenomenon in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output.”

Hector: That's right. But Friedman made this statement repeatedly in the 1970s but, since then, increasingly open economies have had to contend with sharply rising imported input costs which reduced productivity resulting in inflation of the price of goods and services. Varying the volume of money would achieve nothing. So the critical issue, which has been frequently overlooked, has been productivity as opposed to production.

Nevit: Yes you covered that in the last interview but this inflationary effect does seem to happen.
The Economic Consequences of the Bank of England - 1975-2025
Hector McNeill
Expected date of publication: June/July 2024

This book is a revealing account of the impact of monetarism on the British economy over the period 1975 to 2025. The British economist Hector McNeill, reviews the most significant conclusions arising from some 50 years development work that created the new Real Incomes Approach to economics.

McNeill shows that some 25 years in the last 50, experienced cost-push inflation due to imported exogenous energy resource price rises associated with the OPEC 1973 price sanctions and the more recent Ukrainian affair.

The other 25 years saw cost-push inflation generalized as a result of anticipatory pricing with companies attempting to maintain their profits to safeguard future activity and employment and to ensure that their cash flow was sufficient to purchase their next period’s inputs experiencing rising prices.

This reality nullifies the Quantity Theory of Money which links inflation to demand-pull. It also nullifies the logic of monetary policy decisions of applying raised interest rates to reduce inflation because raising interest rates simply exacerbates the cost-push nature of inflation.

McNeill explains the practical mechanisms giving rise to the deindustrialization of the UK economy such as falling investment and inadequate rises in productivity, falling growth and real incomes, rising income disparity and poverty and the second most negative balance of payments in goods on the planet.

In examining Irving Fisher’s 1911 Quantity Theory of Money and the “cash balance” Cambridge Equation produced by Alfred Marshall, Arthur Pigou and John Maynard Keynes, McNeill points out that these identities are not determinant functions because several important variables are missing including the main asset classes, savings and overseas monetary flow balance. McNeill substitutes these identities with a Real Theory of Money which includes the missing variables. Through this identity he shows how assets such as land and properties respond rapidly to rises in money volumes creating a cost-push impact on goods and service companies and rise in cost of living for households. The resulting diminishing real incomes results in lower savings used for investment loan settlements resulting in declining investment. At the same time, the overseas monetary flow balance for a considerable period between 1975 through 2024 saw a significant rise in offshore investment and globalization. This resulted in a declining national industrial and manufacturing base and falling competitivity and the inevitable growing negative balance of payments for goods.

The essential cause of the current plight of the British economy is shown to be a major innovation and productivity deficit. An exploration of the nature of financialization in converting sometimes high physical productivity into one associated with declining national real incomes highlights an indicator which explains the degree to which companies contribute to or reduce inflation. This measure, first used by McNeill in 1975, is the price performance ratio (PPR). This measures the response of company unit output prices to changes in aggregate unit costs.

This associates anticipatory pricing with PPR values equal to or greater than unity (=1.00 or >1.00). Today anticipatory pricing is referred to as “seller’s inflation” or even “greedflation”. On the other hand, a PPR of less than unity (< 1.00) is associated with falling inflation and rising consumer purchasing power or real incomes.

Based on this simple finding McNeill’s Real Incomes Approach is supported by a macroeconomic policy proposition, a “Price Performance Fiscal Policy” (3P) which provides incentives for companies to lower inflation by making corporate taxation a function of a company’s PPR. Therefore, to the degree a company reduces inflation its tax obligations fall, even to zero. The national economic benefit is the dissemination of lower priced goods and services distributing real growth throughout the economy as a result of a general rise in the purchasing power and real incomes of the population both as workers and consumers. Thus, the name of this approach being the Real Incomes Approach.

The essential ingredient to this policy is that companies who volunteer to operate within this fiscal framework can only do so by sustaining a rise in innovation and productivity because the tax rebates can only be received against actual price performance as opposed to “proposed performance”. McNeill provides business rules that can ensure companies optimize their price-setting against feasible unit cost reductions. This is a marked difference to the so-called “Supply Side Economics” marginal tax decreases operated in the 1980s which in the UK resulted in a steep rise in income disparity and with the inappropriate application of interest rates to a massive cost-push inflation seeing over 500,000 households losing their homes due to repossession.

Unlike any contending macroeconomic policy, the Real Incomes Approach’s 3P is able to combine short term price reductions or falling rate of inflation according to the technologies deployed and a sustained advance in innovation and productivity of more-for-less, essential realities for real national growth, actions to address climate change and managing environmental/ecosystem carrying capacity.

Hector: Yes indeed, but the problem arises when one comes to use the QTM as a basis for decision analysis on what to do to control inflation. The knee-jerk policy decisions invariably work to reduce the volume of money which is assumed to be causing growing inflation. It is here that things go awfully wrong with policy prejudicing constituents.

Before concerning myself with the theory I realized in 1975 that the massive cost-push inflation caused by the OPEC 1973 price sanctions raising petroleum prices sevenfold within a single decade, could not be solved applying conventional policy instruments of interest rates and taxation. Raising interest rates and tax simply exacerbated the decline in real incomes by worsening the cost of living. Constituents suffered. Indeed we have witnessed this lately with the Bank of England's response to the inflation associated with rises in imported petroleum and gas prices by the Ukrainian affair.

What this type of policy response does is to substitute a fall in real incomes caused by inflation by a further decline in real incomes as a result of policy decisions. After all, look at the current impact of interest rates on mortgages.

Even in 1979 Nicholas Kaldor calculated that a 3% rise in interest rates created a 2% rise in inflation.

Nevit: Coming to think about it, that is rather odd. So, why does the Monetary Policy Committee take such decisions?

Hector: The logic of the QTM is that inflation is caused by too much money in the economy so, the simplistic response is for policy makers, following that logic, to attempt to reduce the money volume or demand. There is a sentence by Keynes, I think it is in his General Theory where he suggests it would be good to have a solution to a boom by enabling it to last.

If productivity is rising at a sufficient pace then this is possible without causing inflation.

Nevit: Yes, I think we covered that point in the last interview.

Hector: But here, referring to theory, we find that the theory suggests the wrong solutions. For example, in a exchange between Nicholas Kaldor and Milton Friedman in the Lloyds Bank Review in 1970, Kaldor referred to Friedman's "New Monetarism" as assuming that by feeding in more bank finance into the economy this would increase demand and therefore generate growth. So the operational issue is demand-pull and not cost-push. However, Kaldor explained in his statement that Friedman had things the wrong way round. So demand does not come from decisions by the central bank or private banks feeding more money into the economy per say but rather it is generated specifically by companies deciding to expand production or productivity, using funds from banks to pay for, as yet, not produced output. Thus the availability of this eventual output combined with accessible prices results in increased consumption and growth. The more competitive the prices the more likely that growth will be real growth or a rise in consumption for relatively lower outlays in terms of money, probably with little or no inflation.

Let me make this point clear, consumption rises as a result of there being existing or new products appearing and whose prices are competitive and within the bounds of affordability of consumers. So a growth in demand rises as a function of investment and productivity increases, which in turn arises from business decisions and not from decisions emanating from banks or the Bank of England. This distinction as to the origination of demand turns out to be a very important but subtle point. I will elaborate on this later on.
The Cambridge Equation

A basic representation of the Cambridge Equation based on the cash balance approach elaborated by Marshall, Pigou and Keynes is as follows:

(M-s).V = P.Y


M is the volume of money;
s is savings;
V is the velocity of circulation;
P is the average price of goods and services;
Y is the quantity of goods and services transacted also referred to as real income.

Please note that this version of the Cambridge Equation is adjusted to comply with the logic of a subsequent Real Theory of Money (RTM).

Nevit: I will remind you at the end. But this conventional growth logic is the same as the inflation logic in that increased demand causes growth but also inflation.

Hector: Thank you. Yes, it also creates a cascade of additional effects including rising income disparity, declining investment and a host of other things best explained by observing monetary policy decisions and examining the theory upon which such decisions are based.

In the 1920s Alfred Marshall, Athur Pigou and John Maynard Keynes all turned their attention to the QTM to suggest it did not represent reality in the sense that it did not include the fact that savings would remove money from circulation thereby, according to the QTM, result in prices or quantities of goods and services declining. They referred to this as the cash balance approach.

Nevit: Did that result in a change in the monetary identity?

Hector: Well it resulted in several versions of what became known as the Cambridge Equation, all based around that single theme that savings reduce the money volume in transactions. But the fundamental point was that savings had to be subtracted from money volume to bring the QTM in line with that logic (see box on right).

Reference to this savings variable was also referred to as a theory of liquidity preference. Thus, individuals and companies don't spend all cash available but maintain a small balance to respond to short term contingencies. Keynes went on to refer to liquidity preference at some length in his General Theory.

Nevit: I am curious to see the tie up between what we discussed in the last interview, that is, Price Performance Fiscal Policy and your new version of money theory.

Hector: We are getting there.
The Real Theory of Money (RTM)

The expanded Cambridge Equation creates an extended theory of money containing an additional 10 variables to the QTM.

The basic identity is as follows:

(M-(l + r + m + p + a + h + f + c + o + s)).V = P.Y


l is land;
r is real estate (buildings);
m is commodities;
p is precious metals;
a is rare objects and art;
h is shares;
f is financial instruments;
c is cryptocurrencies;
o is overseas flow balance;
s is savings.


All of the added variables represent holding positions which on balance that can be stores or sources of funds as well as having a net value of zero.

Stores can become sources.

Transactions involving stores can result in all or some proceeds being transferred to savings as is often the case in wealth portfolios.

Money flows to cost of living items, goods and services are removed from the control of the buyer with such transactions acting as drains.

Reflecting on the Cambridge Equation we are looking at source, store and drain relationships. So money flows from a source such as a wage paid to an employee. Some of which can end up as savings or a store of money and the rest on essentials. The difference is that the savings store represents money that can yet be used while what was spent on essentials is no longer available, it has drained away from the control of the original owner of those funds. So we are dealing with money sources, stores and drains.

Just as an asset such as a building acts like a store of value, the sale of the building results in a receipt of money which can be deposited in a bank account or spent either on another asset or goods and services and thereby drained away.

Therefore products which are not goods and service cost of living items can act to take funds out of circulation either by being assets or a savings bank account.

However, at some point savings can become the source of additional funds spent on something which acts as another store or a drain.

However, savings are not the only store which absorbs money since there are several classes of assets, flows of money overseas and savings, as already noted. Therefore a baseline modified Cambridge Equation which includes these variables and becomes a more realistic representation of the factors that influence the relationship between the volume of money and the average prices of goods and services. I set this out as a new relationship entitled the Real Theory of Money which includes 8 major asset classes, overseas monetary flow balance and savings (see box on the right).

Each asset class is associated with an intermediation service generating fees and commissions for agents and brokers who sell assets. Depending on the asset class, individual broker and commission agent fees can vary for a few hundred pounds to several million pounds per trade. Most brokers and their company executives maintain wealth portfolios where they allocate the funds, in excess of their normal cost of living outlays, usually on land and buildings and interest bearing savings in a bank. The important point to note is that over the last couple of centuries, thousands of brokers and commission agents have been purchasing assets and leaving funds in interest earning accounts.

No matter what the Bank of England has been doing over the monetary policy cycles to control the prices of goods and services, there has been an incessant growth in asset prices and savings which have removed money from circulation while pressuring cost-push inflation emanating from the asset price rises.

Each asset variable in the Real Theory of Money is a tag or identification of the asset involved and which acts as a store of value and, on closing these positions through a sale, provides a source of money. For example the purchase of an asset represents the creation of a position as a store of value, usually appreciating in value. On selling the asset or closing that position the monies received, in many cases, are transferred to a bank account. Therefore many different assets represent an encapsulated arrangement containing two forms of stores of value as an asset and/or an interest bearing savings account.

The net result has been very significant growing concentration of income and wealth in the hands of a very small number of constituents who are associated with the domain of asset trading and holding.

Nevit: That is very different from the QTM which seems to have overlooked this relationship between assets and savings. So, could you make reference to some of these additional RTM variables to illustrate what this identity adds in terms of useful information that is absent from the QTM.

Hector: Looking at the first three variables of land (l), real estate (r) and commodities (m). Let me first elaborate on what these are.

Land is agricultural land and land used for infrastructural and building site land projects. Land is normally considered to be appreciating store of value.

Real estate is commercial retail units and offices, industrial units, storage and warehouse units as well as housing. Real estate, like land is normally considered to be appreciating store of value.

Transactions in land and properties generate a constant flow of sales commissions and conveyancing fees supporting a constant growth in prices as well as wealth portfolios containing land and properties and interest bearing funds in a "savings" category.

Commodities are those commodity positions that take up temporary roles as assets or stores of value as futures contracts including food, fibre and feedstocks, hydrocarbons as natural gas and petroleum and petroleum products in the form of fuel oil, diesel, gasoline, aviation fuel and lubricants and an additional 6,000 petrochemical derivatives including products entering all sectors such as plastics and fertilizer. So when, for example, under quantitative easing combining a large injection of funds into the economy at very low interest rates induces a flooding of these markets which induces price rises which becomes a spiral in that, the simple act of purchasing and a slight delay on reselling, results in a profit.

Transactions in commodities generate a constant flow of sales commissions and fees which can be extremely high in the petroleum and gas domain supporting growing wealth portfolios containing fixed assets such as land and properties and interest bearing funds in a "savings" category.

However, as the assets of land, property and commodities become inputs to the production or servicing of goods and services this creates what was a demand-pull-like impact on assets to become a cost-push impact on goods and services production.

The response of most companies to rising costs is to operate in an anticipatory pricing mode to increase prices to secure their profits. This is a logical act to guarantee future activity, employment and build up cash flow to be able to afford the input requirements for the next operational period, that are facing rising prices. Anticipatory pricing has a sound financial justification but it has the effect of disseminating cost-push inflationary pressure throughout the economy.

Because most land and building pricing and rentals are subject to rising valuations and are adjusted through contracts, these asset price impacts are delayed until contracts are renewed so there is a delay in this rise in cost-push inflation by around 18 months to two years on average. This, by the way, was the mechanism that I was trying to identify as a student and which Friedman, at the time, could not explain.

Nevit: Ah, thanks for explaining that point. You seem to be saying that monetary policy has unwittingly contributed to the creation of an increasingly wealthy one percent or five percent.

Hector: Yes, monetary policy, because of an application of a flawed basic theory in the QTM as policy and basis for policy decision making, is the main contributing cause of this phenomenon. Let me complete the descriptions of the asset classes. Although they are all different their impact on wealth concentration follows a similar pattern.

So, in the precious metal categories (variable p) there are some industrial metals that include copper and tin as well as silver also act as assets which along with gold, platinum and palladium that are considered to be assets as good stores of appreciating value to hold when economic circumstances become precarious.

Sales commissions on precious metals are relative low but the per instance transactions can be substantial leading to high fees and commissions which tend to gravitate into wealth portfolios containing assets and interest bearing accounts.

Rare objects and art (variable a) is a select market normally used by high income investors considered to be appreciating stores of value.

Shares (variable h) are essentially a financial asset which under quantitative easing attracted funds under buy back schemes leading to rises in the stock market's nominal value. Under normal circumstances shares reflect the evolving performance and prospects of a company. However, some 50% of the stock market rises under the first phase of quantitative easing were related to share buy backs. These share price rises did not reflect improved prospects, investment or good p/e ratios but generated a form of a misleading investment image.

Sales commissions on share brokerage are relatively low but the cumulative transactions can end up with a substantial sum over time, again gravitating into wealth portfolios containing assets and interest bearing accounts. During the quantitative easing period banks sometimes lent companies money at low interest rates to buy back their shares and paid back from the significant rises in share value.

Financial instruments (variable f) include derivatives and other financial products largely located in the grey market which has a massive value reaching the dimension of national economies. Naturally most people earning their incomes from wages are not involved in this domain. It is dominated by banks and hedge funds. Therefore, although circulating money is not the source of derivatives purchases the results of closing derivative positions, or trades, can result in addition flows entering the money volume via individual bonuses and receipts, ending up in wealth portfolios. This is a convenient location to place trading covering all bank transactions and positions where traders can earn very high bonuses leading to the same sort of growth in asset holdings.

Overseas flows are the interesting case (variable o) because after 1975 this became a virtual black hole where investment funds flowed abroad acting as a drain rather than remain within the country, the associated result was the initiation of a major deindustrialization, declining rates of productivity rises and the circulation of profits outside the country often routed to avoid taxation in the UK.

Nevit: You mentioned the flow of money into assets and interest bearing savings. Are there any estimates of the value of these portfolios that seem to be locked out of the money in circulation?

Hector: Well, the principal assets in these portfolios are land and property and these alone in 2024 in the UK, constitute an estimated value of around £11 trillion. This is based on a SDAG projection of 2022 ONS data. That is almost five times the current national GDP of around £2.3 trillion. Of this £11 trillion about 50% of that is land (£5.5 trillion) and roughly 20% of that is dwellings (£2.2 trillion) and 16% of that is other buildings and structures (£1.75 trillion).

Nevit: Is there an unaccounted missing proportion there?

Hector: Well observed, yes there is about 15% held in other forms of wealth. This does not include the associated savings within the portfolios concerned. By the way, the associated national debt is £2.7 trillion which exceeds the GDP.

Nevit: But these are extraordinary figures. How were they estimated?

Hector: Well, land and structures valuations are an evolving field. Of late, the Office of National Statistics produced estimates both in 2017 and 2022 by applying what is known as the residuals approach. Since land is not a manufactured product the science of valuation is limited to essentially average market valuations. There are two other bases for valuation, the investment value and feasibility value but these are not applied. In reality they would render land values to be lower.

However, the important point is that after a few centuries of operations, forgetting for the moment derivatives emerging in the 1970s and cryptocurrencies which emerged in the early 2000s, an important result of monetary policy decisions has been that funds held by high income earners have found their way into what are essentially encapsulated markets which are exclusive and not generally participated in by the general wage-earning public with a result that people and companies operating in the asset and commodity fields have purchased land and buildings and maintain a reserve holding in the form of savings (variable s). In this context I am extending the definition of savings to embrace a wide range of money stores in hand or in any form of interest earning arrangement both on call and medium and long term arrangements.

For some reason Marshall, Pigou and Keynes limited their attention to liquidity preference and short term holdings when a large part of savings, and longer term savings in particular, have an important role in providing settlement funds for payments by different banks against receipts paid against loans of other banks. Put another way, savings are a source of retail loans as well as investment loans for business. Having said that, it is important not to exaggerate the role of bank finance in investment. Most investment comes from company cash flows.

One notable conclusion from the Friedman and Kaldor exchanges was that Friedman seemed to exaggerate the role of bank finance in investment and growth when Kaldor noted that banks only contributed to less than 20% on investment funding. Even today a recent Bank of England Bulletin article showed that only about 20% of SME investment funding comes from banks. There is a general dissatisfaction on the part of SMEs with loan conditions including interest rates and required collateral which is considered to be excessive.

As in the case of research and development funding, most investment funding comes from the private business sector. These funds come from a stream of funds generated by company cash flow. Usually this is, in reality an economy made by the company over and above the payment of the baseline inputs and workforce wages and profits. However, these are not considered to be savings and although accumulated in bank accounts they are spent on investment but do not fall into the same category as savings made by the public or companies.

Nevit: You have said more than enough to explain why the current quantity theory of money is flawed. I can now see why your policy proposition Price Performance Fiscal Policy (3P) is able to counter the more negative aspects of monetary policy decisions. However, in the policy discussion while we covered the impact of rising asset prices on goods and services inflation I don't recall any direct connection between the asset accumulation and 3P. I think we have covered the theoretical aspects and suggest that ask you perhaps mention salient points linking this asset issue with 3P.

Hector: Well, this asset issue has created a massive rentier sector whose growth accelerated during the overseas flows and deindustrialization of the country. Today the most successful countries all have increasingly efficient industrial and manufacturing sectors. To regain growth and recover from the current economic predicament, policies need to be geared to providing positive incentives to increase productivity across all sectors, but in particular, industry and manufacturing. Therefore there is a need to encourage a move from finance and loans which SMEs resist and to move towards equity and growth strategies that generate enough investment funds from corporate cash flows.

3P encourages lower risk investment to increase productivity in order to enable price moderation and even reduction to raise the real incomes of the population in general and in particular work forces. 3P helps companies penetrate markets to diffuse lower priced products and services and raising income and consumer purchasing power. This should, in most cases, help move SMEs away from any need to consider debt solutions to self-sustained growth with investment coming from cash flow.

Productivity is the critical current problem facing this country. It is an imperative for the future wellbeing of the constituents of this country that this is addressed. It is worth reminding ourselves that the repeated bouts of austerity in the past were associated initially with attempts to correct balance of payments imbalance, when the cause of the imbalance was invariably declining productivity. Because both the theory and policy is flawed, policy did nothing to address our productivity problem and the solution was to prejudice constituents. As a result, within the last 50 years, we now have the second most negative balance of payments for goods on the planet and lack the necessary critical mass to ensure resilience in industry and manufacturing. The Bank of England switched emphasis to inflation control but again, because both the theory and policy is flawed, policy has never eliminated inflation. The reason is the same. There have been no serious attempts to design and implement policies designed to increase productivity.

In these interviews I have attempted to describe a policy solution to productivity and to the question of inflation in the form of 3P.

Nevit: Just to remind you. You stated that you would explain why the identification of the origination of demand is important.

Hector: Thank you. This goes back to Nicholas Kaldor's criticism of Milton Friedman's notions of growth. A sustained real growth in demand is achieved as a result of a rise in real incomes as opposed to growth in nominal incomes. This comes from innovation and through the production of products and services that are more accessibly priced made possible by lower unit costs achieved through raised productivity. The subtle but fundamental point is that inflation is not only caused by a rise in money volumes but more so by a failure of productivity to rise to counter inflation through more competitive pricing.

It is evident that the Bank of England mandate of controlling inflation through the application of interest rates needs to be changed. As a monetary organization it would be better to limit this function to a control of the monetary volume in terms of issuance of money and to pass the control of inflation to a fiscal functions like 3P which also have the function of proactively promoting productivity. It is clear that real growth can occur with money volume rising at a slower rate than rises in productivity so as to raise the purchasing power of the pound. This is not the same as Friedman's advice to ensure that production rises at the rate at which money volumes rise, in which case the purchasing power remains the same.

Nevit: On that theme, how is productivity represented in the Real Theory of Money. This is not obvious even although you suggest this is the most important factor.

Hector: You are quite right. I haven't discussed the next stage on from the RTM version which is a Value Theory of Money. This takes into account productivity in order to predict or explain actual price levels. So, we are concerned to know where prices end up after a specific period. This involves a difference or record of the change in status or values of all of the variables and including savings. This establishes the estimate of the net money volume. Then, by recording the average price performance ratio (PPR) over the same period, an estimate of the average price movement can be calculated. If the PPR is less than unity there will be a reduction in average prices. In practice this relies on the operation of a 3P policy framework.

This is still under development. However, paradoxically for 3P to work does not require a finalization of the theory because it has the beneficial impacts based entirely on microeconomic realities where the action is. All of the Theories of Money are attempting to rationalize mega macroeconomic aggregates with a way to explain movements in the prices of goods and services which without productivity estimates is not possible.

This applies to the QTM and the Cambridge Equation and it also applies to the RTM because without 3P in operation moderating the PPR it can't predict price movements. The Value Theory of Money represents an advance over the QTM and Cambridge Equation because it is associated with a definite policy which addresses the productivity and price moderation or reduction issue. The failure in monetary policy has been the failure to associate it with policies geared to increasing productivity. This theory is by no means perfect but it is a definite advance grappling with factors that influence the prices of goods and services which are absent from the other theories of money.

Nevit: I find this quite convincing and lament that I don't see anything like this being offered by any political party in this General Election.

Hector: Well, this all depends on their economic advisers. It is somewhat unreal how these political parties are talking about fully costed meagre provisions and proposals scraping around for revenue and with few making propositions to raise the sums required. 3P can reduce inflation rapidly as a result of specific 3P business rules provided in my forthcoming book. At a 2% inflation rate there is a £45 billion growth potential sitting there which can be converted into real growth by eliminating inflation. On the tax horizon a 3% tax on 50% of the land assets would raise £165 billion. There is a need to move away from the aggregate demand or money volume approach to macroeconomics and to transition to a production, accessibility and consumption approach. In other words, forget about manipulating the volume of money and concentrate of productivity in the production of goods and services that are accessible in terms of price to the population and thereby generate growth associated with rising real incomes.

Introducing 3P would be best on a voluntary basis and to key sectors. Energy and utilities are obvious candidates. 3P can, in particular help SMEs raise productivity and competitivity at a lower risk, most of whom consider bank finance to be too risky.

Cooperatives and mutuals who have a natural costs advantage, not having external shareholders, could become very competitive under 3P. Within sectors, those who participate in the 3P option will find themselves becoming more competitive than plcs who operate under the conventional tax regime.

Nevit: Thank you for your illuminating replies.

Hector: Its been a pleasure.