I am grateful to contributors for some thoughtful comments on the boom and bust question.
There is general agreement that the ERM period and the era of combining an ‘independent’ central bank with big rises in spending and borrowing did not work. I have been asked to explain how the Uk could follow an honest money policy.
The answer is as we did in the two better periods of low inflationary growth, and as Germany did for much of the post war period in the last century. The authorities set a target for money growth and adjust interest rates and banking regulations accordingly. They seek that Goldilocks approach, neither too tight nor too lax. Print too little and you have a credit crunch and deflation. Print too much and you have an inflation. Allow banks to expand too much relative to their capital and you inflationary overstretch. Stop banks lending enough and require too much capital and you have recession.
Some say you can never trust politicians, or for that matter their appointed independent authorities, to run a fiat currency in a non inflationary way. Yet history shows that some countries can succeed with low inflationary growth and sensible money policies for quite long periods. Any individual country can be blown off course by external events and by political decisions to tolerate a bit more inflation, but there should always be people at such times exposing what the authorities are up to and trying to use the pressure of public opinion and elections to get things back on course.
Some say we should return to the gold standard. If paper money had to be backed by gold the authorities would be prevented from debasing money. Past experience of the gold standard shows that politicians may well conclude if it gets too tough to stay virtuous that they will abandon it, so gold provides no final solution to inflationary preferences.It also brings other hazards. As advocates accept, if the supply of gold does not keep pace with growth in the world economy it is deflationary. Such a policy endows those states that mine gold, and states that happen to have kept or acquired substantial reserves in gold as opposed to bonds and foreign currencies. The Gold standard in the UK is associated with a particularly unsuccessful policy period bring on recession and susbtantial job losses.
It is true that both money targets and gold raise the issue of the velocity of circulation. If velocity changes then the quantity theory is affected. If for some reason velocity increases, then you clearly need less money to sustain a given level of wealth and trade. Most economists conclude, however, that it is possible to set sensible money targets to influence both the price level and the output level. They need to look out for any important changes of velocity as they do so. None of it is a precise science. It requires judgement, and corrections if things start to go awry.