How high do rates need to go to control inflation?

The FT has a good article discussing the views of James Bullard and Christopher Waller on Fed policy:

In a statement released on Friday, Bullard, a voting member of the policy-setting Federal Open Market Committee, said a half-point rate rise — a tool that has not been used since 2000 — would have been “more appropriate” than the Fed’s quarter-point increase, given the strength of the labour market and broader economy, as well as the “excessive” level of inflation. . . .

Bullard noted on Friday that US monetary policy had been “unwittingly easing”, as rising price pressures have pushed short-term “real” or inflation-adjusted rates lower and kept them well into negative territory. At these levels, rates remain highly stimulative, spurring borrowing and the very demand the Fed is seeking to dampen.

Biden should have picked Bullard to chair the Fed.

Waller also has some interesting observations:

Christopher Waller, a Fed governor, said in an interview with CNBC on Friday that though data were “screaming” for a half-point move this week, geopolitical tensions justified proceeding with “caution”.

However, he backed a “front-loading” of interest rate increases this year, which he said implied half-point rate rises “at one or multiple meetings in the near future”.

How high does the Fed need to raise rates to control inflation? It depends on what sort of monetary policy they adopt.

“But wait, aren’t interest rates . . . like, monetary policy?

No. Actually, they aren’t.

The Fed would not have to raise interest rates as high with a tighter monetary policy as it would with a looser monetary policy. When it abandoned FAIT, the Fed made monetary policy much looser, hence they’ll have to raise rates higher than if they had stuck with FAIT. As a result, there is more likelihood that the yield curve will invert.



13 Responses to “How high do rates need to go to control inflation?”

  1. Gravatar of Spencer Bradley Hall Spencer Bradley Hall
    20. March 2022 at 14:32

    People are sheep. Interest is the price of loan funds / credit. The price of money is the reciprocal of the price level.

    Since Powell disavowed the metric money, he will never be able to control / stabilize the economy.

  2. Gravatar of Spencer Bradley Hall Spencer Bradley Hall
    21. March 2022 at 04:20

    If you look at the IOR during the GFC, the remuneration rate exceeded all money market interest rates and extended into the capital market for another year. I.e., the remuneration rate was very restrictive.

    Today, the IOR @.40% only extends up to 3mo Daily Treasury Yield Curve rates. I.e., the IOR is not restrictive. It is expansive.

  3. Gravatar of Kester Pembroke Kester Pembroke
    21. March 2022 at 06:45

    Raising rates could result in an interest/price spiral.

    The standard line is this from the Bank of England:

    when we raise Bank Rate, banks will usually increase how much they charge on loans and the interest they offer on savings. This tends to discourage businesses from taking out loans to finance investment, and to encourage people to save rather than spend.

    MMT shows us that The Myth is not compatible with how banks work. Loans create deposits. So if there are fewer loans then there will be fewer deposits.
    Overall if loans go down, financial savings must go down by exactly the same amount.

    If you want the stock of bank loans to come down, while the stock of bank deposits goes up, then, unfortunately, reality won’t let you do that.

    Interest is paid to banks which is earned by bankers, depositors and bank shareholders who spend it with firms. Why? Because prices are going up and they need the extra income too!

    What’s the difference between that and truck drivers getting higher wages, who then spend it with firms because prices are going up?

    If wage increases causes prices to go up, then interest payment increases will cause prices to go up. You can’t have it both ways.

    Interest rate rises will control inflation?

    But they take a year or eighteen months to do so according to theory.

    Interestingly in that period of time the increased level of transactions when run past percentage tax rates will generate a higher level of tax take than it otherwise would have. Alongside the reticence of government to spend as there is a boom on, that causes a reduction in spending flow via the automatic stabilisers.

    But of course it is the Wizard of Oz that is controlling inflation, not the man behind the curtain.

  4. Gravatar of Kester Pembroke Kester Pembroke
    21. March 2022 at 06:46

    If a firm pays interest of $100 to a bank, that bank pays $100 to bank workers and shareholders. Those bank workers and shareholders spend the extra $100 with firms which covers the interest.

    If a firm pays wages of $100 to workers, those workers spend the $100 with firms which covers the extra wages.

    If bank workers pay $200 to a firm, that firm pays $100 to workers and $100 to its shareholders, who then pay $100 each in interest to the bank which covers the expenditure of the bank.

    It all just goes around in a circle. An Interest/Price circle – as I explained.

    Which is potentially inflationary.

  5. Gravatar of Kester Pembroke Kester Pembroke
    21. March 2022 at 06:49

    When there are rising prices people are going to spend what they earn because they need it to buy things they need. And that’s why interest rates don’t work when you have cost push inflation on items with inelastic demand – as we have now with gas. Nobody is going to be doing the increased saving you are relying upon.

    The opposite is the case. Interest rate increases government sector spending, via interest rate payments on reserves, which puts more money in the system and *causes* inflation – both by direct injection and by making the future price of money more expensive, which then feeds into the cost of goods and services. Turkey being the current poster child for that problem.

    As usual with mainstream theory fans, you have it entirely backwards.

    MMT shows that interest rate rises are the cause of inflation (the academic inflate bit, not the price changes because of lack of supply bit), and that the natural rate of interest is zero. Therefore interest rate setting is an artificial market intervention that doesn’t work and should be abandoned.

    Similarly the view that banks should be regulated on the asset side – via the quality of their loan book, rather than the liability side – via the Basel nonsense is a policy that arises from understanding how banks work.

  6. Gravatar of Kester Pembroke Kester Pembroke
    21. March 2022 at 06:54

    inflation is controlled by buffer stocks, not interest rates. You remove people from high paying roles and put them on low paying roles or unemployment. The MMT analysis is that ‘interest rate changes’ only work to the extent that they make and keep people unemployed – both workers and profit seekers.

    The unemployed then have less money to spend and the distributional conflict that is inflation – who gets what – is resolved by the newly unemployed getting less.

    That resolves the expectation issue and puts it where it needs to be for stability. Workers expect to lose their jobs if they ask for more money because there are many other workers after their job. Profit seekers expect to lose sales if they ask for more money because there are many other profit seekers after their market share.

    The buffer stock is the stabilisation mechanism in the economy. Nothing else.

    So then the analysis moves to “which is better: an unemployed buffer stock or an employed buffer stock”

    An unemployed buffer stock leads to a large transition gap – the difference between the unemployment ‘wage’ level and the wage/cost level the private sector has to pay to get the unemployed work ready and into work. That is a dead loss to the economy which can be eliminated by changing the unemployed buffer stock to an employed buffer stock.

    In other words the cost of the transition gap is greater than the cost of hiring people away from the private sector to supervise and manage a Job Guarantee. Moving those few people collapses the transition gap. Overall that is more efficient and leads to a far greater GDP than can be achieved by interest rate targeting methods.

    The Job Guarantee is the system stabilisation mechanism that is superior to the ‘Unemployment Guarantee’ we have as the current system stabilisation mechanism. (The other reasons the JG is superior are discussed here:

    Arguably it would be better to talk about it as a separate ‘stabilisation policy’ – the buffer stock along with the base level tax required to produce the necessary fiscal drag that helps make the buffer stock work by forcing the currency to circulate widely.

    Then ‘fiscal policy’ can just be ‘tax and spend’, and ‘monetary policy’ can just be ‘regulate the banks’.

  7. Gravatar of ssumner ssumner
    21. March 2022 at 08:14

    You guys are worse than the Russian trolls.

  8. Gravatar of mira mira
    21. March 2022 at 08:34

    Not a Russian troll here. Am I correct that it seems that your favor towards Powell seems to have evaporated? You were singing his praises not too long ago, no?

  9. Gravatar of steve steve
    21. March 2022 at 10:02

    reading all this gibberish only proves that economics really is the dismal science…

  10. Gravatar of Tacticus Tacticus
    21. March 2022 at 11:07

    Out of curiosity, Prof. Sumner, what would you have voted for at the last meeting, if you were on the FOMC? With NGDP at its current rate, even 50 bps feels like a joke.

  11. Gravatar of Jim Glass Jim Glass
    22. March 2022 at 11:01

    There’s no need to raise interest rates at all!

    The MMTers finally convinced me of this. It took a while, but reading Kelton’s book finally won me over. Fact is, interest rates *can’t* cut inflation.

    The key is government spending. Get inflation, slash government spending to reduce it.

    That’s what all the MMTers (and their progressive politician fans) are advising now, right? Cut government spending! I haven’t checked, but I’m sure it is.

  12. Gravatar of ssumner ssumner
    22. March 2022 at 17:05

    Mira, Yes, and yes. When he did well I praised him and when he did poorly I criticized him.

    Steve, You are such a witty troll. “Dismal science”! Who else could have coined such a clever putdown. I take my hat off to you.

    Tacticus, I’d have voted for 50 basis points, or maybe 61 basis points. (Why move in quarter points?) But that’s not what’s important. The big mistake at the Fed was walking away from FAIT—a huge mistake. That’s the primary reason we have an inflation problem in the first place.

  13. Gravatar of Kester Pembroke Kester Pembroke
    29. March 2022 at 06:57

    Jim, or bank regulation. Has deflationary effect economy

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