That Doesn't Mean What You Think It Means

3.Money is endogenous.

When there is no interest paid on bank reserves, it’s true that pegging rates makes the money supply is endogenous, which means it cannot be changed at the discretion of a central bank.

From this valid claim, MMTers wrongly conclude that under an interest rate targeting regime the central bank cannot adjust the money supply to control inflation.

In fact, even under interest rate targeting, central banks can and do adjust the money supply to target inflation, as during the period from 1983 to 2007.To adjust the money supply appropriately they must frequently adjust the interest rate target, but they are quite willing to do so as required to stabilize inflation. They didn’t target the money supply during 1983-2007, but they used OMOs to adjust the monetary base as required to control inflation.

4. Interest rates are an exogenous monetary policy instrument.

On a day-to-day basis, it’s true that central banks can and do target short-term interest rates.

From this valid claim, MMTers wrongly conclude that changes in short-term interest rates reflect changes in monetary policy.

In fact, over any meaningful period of time, short-term interest rates are mostly endogenous, determined by factors such as the income and Fisher effects. The Fed merely follows along to prevent an economic disaster. As an analogy, at any given moment in time the path of a bus going over a mountain range is determined by the driver’s handling of the steering wheel, but over any meaningful span of time, the path of the bus is determined by the layout of the road, combined with the bus driver’s desire not to go over the edge of a cliff. In this analogy, the twisting road is like the fluctuating natural rate of interest. As I pointed out in this recent post, MMTers don’t understand that if the central bank targets inflation then interest rates become endogenous, and positive IS shocks cause higher interest rates.

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