Sunday, November 13, 2011


I bet you thought I made a spelling error in the title above (Got ya!) I am a terrible typist. I often type too fast and hit the keys out of sequence, and have often attempted to type the word "inflation" and instead type "infaltion". The other day I did it, and it hit me that this misspelled word perhaps could be interpreted as a compound word meaning "false inflation" or a new word that represents the concept that the entire monetarist or quantity theory concept of inflation is FALSE.

Well that might be a good new word to add to the lexicon of truth, because the monetarist concept of so-called "inflation" is false under a state currency system that is free floating and non-convertable. There is NO SUCH THING as "inflation" any more; at least as it is defined in the monetarist's view.

For a start, let's look at the video below where several of the 1st generation MMT thought leaders discuss the concept of "inflation" under a FFNC state currency system; fast forward to the 13:00 minute mark.

At the end of the segment that answers the audience member's question about inflation, Warren Mosler and Bill Mitchell discuss how under a FFNC state currency, it is always the government, what Warren often calls the "currency monopolist", that ratifies higher prices in the economy. Here's an excerpt from the transcript:

Warren Mosler: I guess I’ll go to Bill’s point first, that you don’t get inflation until you’ve used up the resources. And the other thing is, there’s a whole question of what is actually inflation and what are just price increases, and in this country we look at CPI. [01:03:47]

What happened in the 70s was we had an external monopolist in OPEC that was raising prices of oil, and it went from $2 to $40 dollars, and those costs were passed through, had nothing to do with monetary or fiscal policy. And in fact, the inflation broke after the cartel broke, which was largely based on, I think, the deregulation of natural gas in 1978. Where it had been capped at below market levels and so no one was producing any natural gas. We lifted the cap, the price went up to two-fifty or -sixty or something, and suddenly natural gas was everywhere, the electric utilities converted, and OPEC tried to sustain prices. They cut production by, I think, over 15 million barrels a day in the early 80s. Finally they couldn’t handle it, the price collapsed, and the inflation went away. I don’t attribute any of the success in the war against inflation, whatever, to monetary policy at the time, I see it as an underlying thing. [01:04:47]

The other kind of inflation, the kind of inflation that you can get from the monetary system is the demand pull, rather than the cost push, and that, I’ve frankly never seen that in my 40 years. I’m sure it’s possible, and you see it in some countries, occasionally, but you have to get to full employment, run out of resources, and then the government has to continue to be pushing it past that point, and you use the price signals. Right now, we have an enormous output gap by any measures, some might say it’s smaller than others, but it’s certainly large enough where that’s clearly not the problem. I’ll let somebody else continue, just to fill in. [01:05:24]
Bill Mitchell: The question about the OPEC is very interesting, because I think Australian experience was similar to elsewhere, but with slight nuance. You’ve got to understand what inflation is, first of all. A continuous price… a price bubble within a specific asset class, which is… that’s not inflation. That’s an issue, so a real estate bubble is an issue, but it’s not inflation, and the public debate tends to conflate housing booms with inflation. It’s a wrong conflation. [01:06:05]

And you’ve also got to differentiate, as Warren did, the “cost push from the demand pull” type inflation. In the mid 70s, all of our oil-dependent economies had very major cost shocks to the system. The question then was, if you think about what that means, what that means is that there’s a real income loss to the domestic economy. That real income loss has to be shared in some way, and then the cost shock just dissipates very quickly. What governments did at that time was to, for political reasons, was to delay the dissipation of that cost shock. And that’s where you do, you can get demand-side factors interacting with the supply-side factors.

Warren Mosler: Through indexation. [01:07:00]

Bill Mitchell: Yeah, because you don’t want to take the crunch, you don’t have a distributional consensus in your country, whereby the workers will take a bit of the real wage cut, the bosses will take a bit of the margin cut, and it’ll go out of the system fairly quickly.

Warren Mosler: Your decline in the real terms of trade. [01:07:27]

Bill Mitchell: That’s what I’m saying. So you can get an inflation then feeding on itself if the workers and the bosses have a slug-out fest in a distributional struggle where each of them has price-setting power and they can defend their own margin, the real wage and the profit margin, and the government ratifies that through indexation.
Here's my interpretation: In the US for instance, if the oil cartel gets control of the price of petroleum for a time (such as now) then the higher energy prices work their way into the general price of products in the economy and the government does Cost of Living Adjustments (COLAs) in the transfer programs (Social Security, Medicare, Nutrition Assistance, etc..) and also, they pay the new prices to provision the government, for instance the US military is the largest purchaser of petroleum products in the world. This act by the government of paying the new higher prices is the ratification of the new price.

So with the government as the monopoly issuer of the state currency, they are the natural price setter for everything in the economy. They set prices when they spend to provision the government and make transfer payments. Prices have generally gone up over time solely due to the fact that the government agrees to pay more for things over time.

So it is not as if the general trend of rising prices over time is a function of “how much money is out there” or "money supply" or reserve balances in the banking system or any of that; it is that the currency monopolist agrees to pay the new higher prices that occur due to supply/demand shocks that can happen periodically. So it not correct to look at “money supply” in a FFNC currency system to predict price movements at all. This dogma should have been completely discarded in at least 1972 (if not even before this; this requires more thought).

Under a FFNC state currency system, the long term price trend just depends on the price level that the government sector willingly agrees to pay. Looking forward, if we ever experience inflation again in the US, it will be because the government has agreed to pay ever increasing prices.


Clonal said...

EconProph has a good post on this issue - The Quantity Theory of Money and Fears of Inflation Are Nonsense

We rarely get to conduct scientific experiments in economics, but for the last 3+ years The Federal Reserve has unintentionally conducted a test of an economic theory called the “Quantity Theory of Money” (QTM). QTM makes some very specific predictions – predictions that Ron Paul, conservatives on Wall Street, and others have been repeating a lot. Unfortunately for them, QTM has failed the test.

First, some background on the theory. The QTM is and has been one of the foundations of both monetarist thought and Austrian economic thought. In it’s base form, it’s based on an accounting identity that must, by definition, be true. The notation sometimes varies, but the quantity theory of money is based on a definition called the equation of exchange. This equation goes like this:

M times V = P times Q
M: Money supply
V: velocity of money, or the number of times the average dollar changes hands and is spent during the same time period as Q is measured.
P: price level
Q: real GDP (sometimes real National Income, Y, is used – same thing essentially)

So what does the equation say? If you look at the left hand, M x V, you get a representation of the total spending in the economy. It’s how much money was in circulation times the number of times that money was spent. The right side, P x Q, gives us the value of nominal GDP. It’s the value of all the real stuff we bought (Q, real GDP) times the Price level P which translates it into today’s prices. Put the two sides together and you’ve got total nominal spending in money terms must be the same as the total value of the things we bought. Duh. Of course it is. It’s an identity. It’s the macro equivalent of saying that if I spend $5 each time (M) on 7 trips to the grocery (V) to buy 70 apples (Q) at $0.50 each (P), then I will spend $35 on $35 worth of stuff.

As an identity definition it’s not really very interesting. It’s when economists begin to use it as a model of future outcomes that problems arise.

Matt Franko said...


I would like to see more articles like that which put the wood to monetarism... especially after what we have witnessed empirically over the last few years...


Matt Franko said...

PS Clonal,

I think many of the MMT thought leaders are purposefully very "careful" around the 'infaltion' issue... perhaps not bold enough on this... just imo....


Clonal said...


See also Art Shipman's - The Greatest Scam of the 20th Century

If you take any old Velocity graph -- I'll use the one from earlier today -- and invert it, what you get is the quantity of money, relative to output. Milton Friedman's graph.

But guess what:

It is NOT similar to the long-term trend of prices.

But Friedman said the quantity of money relative to output IS similar to the price trend.

But it is not similar to the trend of prices. In order to make it similar, we have to do what Friedman did......We have to cheat

See also Shipman's Miscellaneous afterthoughts

and also Energy

Matt Franko said...

Clonal thanks more food for thought great work...

If we could go back a bit, it's like the monetarists are saying that the fact that some Roman Treasury official had over 50,000 coins buried in this jar (even though demonstrably nobody else knew about them), was in itself somehow magically causing price increases in Brittannia 2,000 years ago. While by secular accounts the Romans fixed labor at 1 denarius per day.... try going on strike for more back then!


Ralph Musgrave said...

I don’t agree with the 2nd last paragraph of Matt’s article where he suggests that inflation is a function of what the currency monopolist is prepared to pay for sundry products, rather than a function of the quantity of money.

Given an excessive quantity of money, people will have the wherewithal to pay inflated prices for everything. If government refuses to pay market price for products X, Y & Z, suppliers of those products will just stick two fingers up at government and sell to people (flush with cash) who ARE prepared to pay market price.

Shaun Hingston said...

Where is this video from?

Shaun Hingston said...

here is the link.

Matt Franko said...

I think you would get a lot out of watching all of the videos there if you can get the time....

This link has all of the presenters that day, good foundational stuff.


Matt Franko said...

But Ralph,

Where can the people get the excessive quantity of balances that makes them able to spend ever increasing amounts?

For instance, back in 2008, when gasoline first went up here in the US, the economy started to slow due to this price shock. So the Bush administration did a $650 tax rebate to all US citizens that in effect said: "go ahead and pay the higher prices we hereby ratify them" then they raised the social security payments too (5.8%)... this is what I believe Bill and Warren mean by 'ratification', it's done thru the fiscal channel.

Also, in 2003/2004, the price of building materials went sky high here in my local market at least, when Rumsfeld's DoD came in and bought out all the inventories to ship to Iraq at ever increasing prices. Plywood sheets were over $50 and now the same sheet is $13. As one part of the moron government (DoD) was competing with another moron part of the government (banks) to set higher prices for building materials.... again done by govt thru fiscal.

Under FFNC, the wholesale concept of Milton Freidman style inflation is N/A (not applicable).

"Clanging Cymbals", noise, garbage... it's a whole new paradigm... Resp,

MortgageAngel said...

Infaltion- lol Clever! I've got to rant about inflated health insurance premiums. My family, knock on wood, is super healthy. I can't believe how much it costs healthy people to be insured. So, the government should get in the business of health insurance in order to create competition and drive costs down. Is this correct?

Matt Franko said...


I think WM's proposal is to transfer $5k or so of balances at the beginning of the year to buy cat. coverage and fund a HSA, if you dont spend it all you keep the change...