Aside

Interest Rate Changes Under MMT

MMT considers that the aggregate demand impact of interest rate changes are unclear and may not even be negative (for a rise) or positive (for a fall) depending on rather complex distributional factors. For example, remember that rising interest rates represent both a cost and a benefit depending on which side of the equation you are on. Interest rate changes also influence aggregate demand – if at all – in an indirect fashion whereas government spending injects spending immediately into the economy.

This is the reason why MMT proponents do not give priority to monetary policy over fiscal policy.

SOURCE – BILL MITCHELL

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2 responses to “Interest Rate Changes Under MMT

  1. When an economy reaches full employment and full production at stable prices and wages, respectively, it should adjust its spending so that the amount of money flowing into circulation equals the amount flowing out.

    I base this on a model of the economy using monetary flow analysis.

    The basic equation comes from hydrology, which is also about flows:

    IF – OF = ΔC

    Inflows minus outflows from circulation equal change in quantity of money in
    circulation.

    We can expand the above equation to break down the inflows and outflows into distinct flows:

    [E+G+I+L] – [M+T+S+P] = ΔC

    where
    E = exports
    G = government spending, both based on tax revenues and deficit spending
    I = Investment spending
    L = Bank loans (we shouldn’t ignore the role of banks in creating money)
    M = imports
    T = taxes
    S = savings
    P = pay back of loans
    C = quantity of money in circulation
    circulation is money involved in transfers between parties in the economy
    who are exchanging goods and services for money.

    There is a point in time where S = E+G+I+L at some previous point in time.
    Inflows circulate around and around between parties, each transaction involving exchange of money for goods and services, but possibily the one receiving the money may save some of it when he/she uses it to buy something else from someone, so eventually every party saves a bit until all of the money has been saved. This implies that there needs to be a continuous inflow of money into circulation to maintain the amount of money in circulation at a given level. (Think of swimming pools with inflows and outflows of water and the need to keep a certain level of water in the pool–just full but not overflowing.)

    The above equation is a simple differential equation. From it we
    can derive that the quantity of money in circulation C(i+1) equals
    the preceding quantity of money in circulation plus the change in quantity of money due to the net of inflows and outflows:
    C(i+1) = C(i) + ΔC(i+1) = C(i)+ IF(i+1) – OF(i+1)

    Thus if the change in quantity of money in circulation is positive, the quantity of money increases:

    C(i+1) = C(i) + ΔC(i+1)

    If the change in quantity of money is negative the quantity of money in circulation decreases:

    C(i+1) = C(i) – |ΔC(i+1)|

    So, suppose the economy is starting out and needing to grow, then
    we seek to make inflows greater than outflows, and do so until production and employment reaches a point where the quantity of money in circulation C’ is sufficient to clear the market of goods and services produced at full production with full employment.

    Any additional positive inflows at this point will make the quantity of money in circulation excessive, which will be inflationary (the water in the pool will be overflowing its banks). And the treatment for this is to reduce the inflows to less than the outflows until we get back to C’. That is, we need ΔC < 0. Inflows minus outflows is negative. When we get back to C' we should make ΔC = 0. We then have a balanced economy at full employment and production at stable prices and wages. We fight inflation by reducing inflows to less than outflows until we get back to full employment and production at stable prices and wages.

    A balanced economy is not a fiscal balance. Money is fungible. And while it is true that G – T = deficit spending, deficit spending need not be zero, as long as there are other outflows than T to counterbalance the deficit spending and other inflows at full production and employment etc..
    So, there are infinitely many compositions of IF and OF that would just cancel one another. Which means that we should not be focusing on balancing the budget with government spending just equal to tax revenues, but focusing on balancing the economy at full employment and production at stable prices and wages with an appropriate mix of inflows and outflows.

    We thus have a model of a fiat monetary system in which we can specify what produces inflation, how inflation should be fought, what is an ideal situation to reach and how to reach it from a deflated state. No longer must fiat money systems be regarded as necessarily inflationary, because we can show where we must stop growing the quantity of money in circulation to avoid inflation while having full production and employment.

    As for the question about what Australia must do if it has full employment, I think we need a bit more information. Do we have full production? If not, we can have more growth, and ΔC can be adjusted to be positive (usually by applying deficit spending or selling more exports, or getting more investment or bank lending). Do we have inflation or stable prices and wages? If inflation, we need to back off on the inflows of money into circulation. But there are many ways to accomplish this in terms of mixes of the various inflows and outflows.

    BTW, C' is not a fixed quantity. Population growth, changes in exports and imports, and investment and bank lending, etc. can change the quantity of C in circulation at which we optimally have everyone employed at full production at stable prices and wages. C is not a stable quantity. It must be constantly monitored and modified as needed to bring the economy to an optimal balance.

    Stanley Mulaik

  2. stanislaus3

    In the swimming pool model of the economy, interest paid to banks can be entered into circulation once converted to ordinary dollars from reserve dollars as a seperate subentry of G, G = (Gt + Gd + Gi) where Gt is spending backed by tax dollars at Treasury, Gd is deficit spending, and Gi is government spending of interest on securities. A corresponding entry could be considered a part of L = bank loans, L = L(1- i) where i is the net interest set by the banks, not the Fed.

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