Monday, April 18, 2011

Rodger Mitchell - Monetary Sovereignty versus Modern Monetary Theory

Some have asked what is the difference between Monetary Sovereignty (MS) and Modern Monetary Theory (MMT). Others use the terms interchangeably. Actually, while both share many features, there are differences....

The more important difference between MS and MMT is the handling of inflation. MS suggests increasing interest rates when inflation threatens. MMT holds that increasing interest rates exacerbates inflation by increasing costs, and that the correct prevention/cure for inflation is to reduce federal deficits, with higher taxes and/or with reduced federal spending.

MS says:
1. Deficits have not been related to inflation for at least 40 years. Instead, inflation has been related to oil prices. Since deficits have not been the cause, reducing deficits is not the cure.
2. Reduced federal deficits lead to recessions and depressions, meaning the MMT approach leaves a poor choice between inflation and recession, or a very difficult balancing act between the two.
3. Reducing federal deficits cannot be done quickly or incrementally. The questions surrounding which taxes to raise or which spending to cut are slow, difficult, cumbersome and politically charged, as witness the repeated battles over the debt ceiling. Deficit control is ill suited to inflation fighting, which needs fast, incremental action.
4. Interest is a minor cost for most businesses, and an increase in interest rates represents a minuscule increase in business costs – not enough to affect pricing significantly.
5. Money is a commodity, the value of which is determined by supply and demand. Demand is determined by risk and reward. The reward for owning money is interest, so when interest rates increase, investment tends to flow to money (i.e. bonds, CDs, money markets), increasing the value of money. When interest rates fall, investment tends to flow to non-money (stocks, real estate), reducing the value of money. Increased money value is the prevention/cure for inflation.


David said...

I'm not sure if Rodger Mitchell is characterizing MMT correctly with regards to interest. My understanding is that MMT rejects interest rate hikes as the principle tool to fight inflation on the grounds that it is too blunt an instrument and tends to do more harm than good. While he considers the control of inflation one of monetarism's successes, it should be noted that controlling inflation by causing recessions is tantamount to killing the economy in order to save it.

Anonymous said...

I'd agree with this more than MMT. I don't know how else to explain the success of UK NGDP targeting

Tom Hickey said...

Here is a brief explanation of NGDP targeting for those that may not be up on it.

I don't see how this would work. Where is the direct transmission from the Fed to output? Otherwise, any rise in NGDP is purely nominal. That is wagging the dog's tail.

Rodger has argued this with MMT'ers for some time. Their predictable response is that it is the demand and the way to affect demand directly is through fiscal policy. Since monetary policy cannot be targeted like fiscal policy can, it is blunt and inefficient.

But maybe I don't understand Scott Summers proposal sufficiently. I engaged him on this some time ago on his blog, but he was not interested in pursuing MMT at the time. Said he didn't have time to get into it then.

Tom Hickey said...

DAvid: "My understanding is that MMT rejects interest rate hikes as the principle tool to fight inflation on the grounds that it is too blunt an instrument and tends to do more harm than good."

This is correct. Rodger truncates the MMT position a bit. It is that monetary policy 1) is blunt, 2) doesn't directly connect with demand, 3) increases cost, and 4) injects additional NFA by raising the rate that the Treasury pays.

I don't believe in cost-push "inflation" from supply problems. I would not call this "inflation" at all. Calling it "inflation" obscures the real problem and options. To address demand-pull and cost-push the same way ignores their profound differences.

The problem with Rodger's position as I see it is that he views recent inflations as cost-push, due to oil shocks. As I see it, monetary policy (raising rates) cannot deal with supply problem at all effectively.

Rodger Malcolm Mitchell said...

MMT fights inflation by reducing the deficit. That is far more "blunt" (and an awful low slower) than raising interest rates.

The Fed could raise rates a minuscule amount -- .0025 or less -- and do it instantly, without political fighting.

But reducing the deficit requires endless battles about exactly where should the deficit be reduced, followed by a long period of time to see the deficit actually reduce.

It is completely impractical.

MMT's objection is that raising rates, increases costs, so causes, rather than curing, inflation. However, it is the method the Fed has used successfully for more than 40 years.