Endogenous Interest Rates And Aggregate Demand

I’m still trying to figure out the MMT view of monetary policy. It’s not easy for me, because MMTers seem to think that “monetary policy ” and “changes in interest rates” are pretty much the same thing. I view that as reasoning from a price change, but even some conventional economists make that mistake.

For a brief moment on page 406 of Macroeconomics (by Mitchell, Wray, and Watts) it seemed like they understood this distinction:

In a growing economy, it is likely that aggregate demand conditions will improve at times when the market rate of interest rises as the central bank often raises its target rate in an expansion.

Yes! Interest rates are largely endogenous, mostly reflecting changes in output and inflation expectations. When the economy is booming and/or inflation is rising, then market interest rates will also tend to increase. My only quibble is that the authors need not have added, “as the central bank often raises its target rate in an expansion”, as this relationship is true even in an economy that doesn’t have a central bank (say the US prior to 1913.)

But that minor quibble contains the seeds of a major problem, as I don’t know if MMTers even recognize the income and Fisher effects. At times they seem to assume that all changes in interest rates are “monetary policy”, i.e. the liquidity effect.

MWW continue:

[W]e would not observe investment falling when the market interest rate rose because the IRR of each project could also be increasing

So far so good. The internal rate of return will rise with inflation and/or output growth. But then this:

Thus, it is important to avoid applying a mechanical interpretation of the concept of the [Marginal Efficiency of Capital]. Keynes, in fact, did not think investment would be very responsive to changes in the market rate of interest, especially when the economy was in recession or boom.

Woah! The term “Thus” is mixing up two unrelated issues. First, that fact that because interest rates are largely endogenous you often observe interest rates move procyclically. The second (and more dubious) claim is that this is evidence that the economy is not very responsive to interest rate changes. But that doesn’t follow at all. As an analogy, it is true that budget deficits are usually high when the economy is very weak, but even a monetarist like me would never argue that this proves that exogenous increases in deficit spending are contractionary.

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