Bill Mitchell — Japan again demonstrates basic errors in mainstream macroeconomic theory

It is Wednesday and a quite blog writing day for me. I have to catch a flight a bit later and finish some other things before I do that. But I receive a lot of E-mails from readers puzzled by the fact that the low-interest rate environment (even negative) has not stimulated economic activity to the point of accelerating inflation. As part of the paradigm shift that is now, finally, occurring in macroeconomic policy-making, the RBA governor Phillip Lowe continued his theme that monetary policy has basically exhausted its counter-stabilisation potential, when he made his – Remarks at Jackson Hole Symposium (August 25, 2019). He talked about the “the elevated expectations that monetary policy can deliver economic prosperity” against the reality that central banks do not have “the best lever” to manage the economy. This theme has been expressed by many central bankers now. And there is emerging research to show that the low-interest rate environment is actually achieving the opposite – reducing the inflationary pressures. This is no surprise to Modern Monetary Theory (MMT) economists. Our basic presumption is that monetary policy is an ineffective tool for modifying aggregate spending and that rising interest rates, which are designed to quell inflationary pressures, probably actually intensify those pressures through their impact on business costs. Today, I will briefly discuss a paper I read yesterday that adds to the growing research evidence on this theme....

Basically, monetary policy involves a "shotgun" approach while fiscal policy can be as tightly targeted as policy makers wish. A "shotgun" approach means that interest rates affect everyone financially and economically across the board, but the effects on different parties, classes, sectors, etc. is different to the degree that the policy involves choosing winners and losers. That is to say, there are trade offs instead of the assumed binary independent variable-dependent variable function that is naively assumed. e.g., by NAIRU and the Phillips curve. 

As a result, instead of an input (interest rate setting to target inflation and unemployment) resulting in optimizing inflation rate and employment rate, "interference patterns" to use an analogy from acoustics are generated, such that different "waves" (flows) are mutually cancelling to some degree. That is to say, evidence of the value of monetary policy is sparse. It does not work as advertised, and central banks are now admitting this.

On the other hand, fiscal policy, being a political choice by those in control of appropriations, can be targeted to affect different parties, classes, sectors, regions, etc. Again, the policy will inevitably choose winners and losers, but based on a rationale that is simultaneously social, political, financial and economic. Then the principle of the greater good applies, that is, national interest in the case of a national government.

These are simple principles but widely misunderstood and misrepresented, even by some naive MMT proponents, especially those attempting to compromise with the mainstream conventional view. MMT economists have stood their ground, on the other hand, they are finally getting some traction in changing this erroneous view that has been so costly socially, politically, financially, and economically.

Bill Mitchell – billy blog
Japan again demonstrates basic errors in mainstream macroeconomic theory
Bill Mitchell | Professor in Economics and Director of the Centre of Full Employment and Equity (CofFEE), at University of Newcastle, NSW, Australia