I must be a masochist. I feel like Humphrey Bogart, about to slide back into that leech-infested water. But here goes:
Suppose we pick a fairly “normal” year, when NGDP growth and nominal interest rates and unemployment are all around 5%. It might be 2005, 1995, 1985, whatever. The exact numbers aren’t important. Now the Fed does an OMP and doubles the monetary base by purchasing T-securities. They announce it’s permanent. What happens?
One MMT answer is that the Fed can’t do this. It would cause interest rates to change, and they peg interest rates. But the more thoughtful MMTers seem to be willing to let me do this thought experiment, as long as I acknowledge that interest rates would change and that it’s not consistent with actual central bank practices. I’m fine with that.
So let’s say they double the base and let rates go where ever they want. I claim this action doubles NGDP and nearly doubles the price level. MMTers seem to disagree, as I haven’t changed the amount of net financial assets (NFA) at all.
But here’s the Achilles heel of MMT. Neither banks nor the public particularly wants to hold twice as much base money when interest rates are 5%, as that’s a high opportunity cost. So they claim this action would drive nominal rates to zero, at which level people and/or banks would be willing to hold the extra base money. Fair enough. But then what? You’ve got an economy far outside its Wicksellian equilibrium.
The MMTers like to talk about cases where large base injections did coincide with near zero rates—The US in 1932 or 2009, Japan in the late 1990s and early 2000s. But those were all economies that were severely depressed and/or suffering deflation. I find it hard to believe that you could cut rates from 5% to 0% in a healthy economy without triggering an explosion of AD, especially if the economy was already experiencing normal levels of NGDP, normal growth in NGDP, and normal unemployment levels. The closest example might be the US after WWII, but remember that people (wrongly) expected deflation after the war, and by 1951 the Fed gave up on that policy due to rapidly rising inflation.
MMTers forgot that the nominal interest rate is the price of credit, not money. The Fed can’t determine that rate, it reflects the forces of saving supply and investment demand. Hence an attempt to set interest rates far below their correct level in savings/investment terms (the Wicksellian natural rate), would trigger an explosion in AD, and much higher inflation. Central banks know this, which is why after the inflationary 1965-1981 period they adopted the Taylor Principle.
That’s the flaw with MMT; it’s not net financial assets that matters, it’s currency. And the Fed doesn’t set interest rates, markets set interest rates. The Fed can briefly push them out of equilibrium (due to sticky prices) but this triggers big changes in AD and the price level.
The whole point of my Quantity Theory of Money post (and especially the Canadian/Australian comparison) was to smoke out their views of currency and the price level. It was hard sifting through all the comments, which were often on side issues, but it seems they regard base money as just another financial asset. But it’s not, which is why their view of monetary policy is wrong. Indeed in a sense they don’t even have a theory of monetary policy, they have a fiscal theory that implies open market operations don’t matter. But the Canadian/Australian data tells us that currency does matter, and NFA is the wrong aggregate to look at.
This is my very last MMT post . . . until the next one.
PS. Quiz question:
1. Sumner claims that a 5% NGDP growth rule will lead to roughly 5% NGDP growth, 5% interest rates, and 5% unemployment. What would a 3% NGDP target lead to?
Answer: About 3% NGDP growth, about 3% interest rates, and about 5% unemployment.
PPS. The previous MMT post has 292 comments, and counting. I may not have time to answer all the comments here. In that case I’ll answer the 1% or 2% that actually comment on what I say here.