A –> B –> C, Does A Imply C?

I believe the answer is yes, due to “transitivity”. But what do MMTers believe?

Let’s say A is: Big open market operations occur when interest rates are positive.

And B is: Interest rates change by a large amount.

And C is: Has a significant impact on the economy.

The MMT textbook I’ve been reading suggests that A does not imply C:

Monetarists are hostile to the creation of base money to finance deficits because they claim it is inflationary due to the Quantity Theory of Money (QTM). MMT advocates would first highlight institutional practice, namely that net treasury spending initially causes an equal increase in base money.

Second, they would challenge the theory of inflation based on QTM, and argue that if a fiscal deficit gives rise to demand pull inflation, then the ex post composition of  ΔB +  ΔMb in Equation (21.1) is irrelevant. Overall spending in the economy is the driver of the inflation process, and not the ex post distribution of net financial assets created between bonds and base money.

When I first read this I thought:

1. This is a shocking claim.

2. This is clearly wrong.

So I set out to try to discover why they hold this highly controversial heterodox belief. Do MMTers believe that OMOs don’t have a big effect on interest rates, or do they believe that big changes in interest rates are irrelevant?

On page 364, the authors clearly indicate that they believe a big open market purchase could immediately drive interest rates sharply lower, perhaps to zero:

However, this mainstream argument [for a money multiplier] fails to recognise that the added reserves in excess of the banks’ desired reserves would immediately drive the interbank rate to zero or to a non-zero support rate

The term “non-zero support rate” presumably refers to IOER, but we can ignore that since I’m considering a big OMO in 1998, a time when IOER was zero. It is possible that a huge monetary injection could raise interest rates due to the Fisher and/or income effects, but we can rule that out as the authors are claiming “irrelevance”. A policy that has a big impact on inflation and/or real income is clearly not irrelevant. So they are obviously assuming the liquidity effect is the only relevant consideration after an OMO, in which case this MMT claim is certainly true. A big OMO would drive rates much lower, probably to zero.

1 2 3 4
View single page >> |
How did you like this article? Let us know so we can better customize your reading experience. Users' ratings are only visible to themselves.

Comments

Leave a comment to automatically be entered into our contest to win a free Echo Show.