Stagflation Threat: Be Pragmatic, Not Dogmatic

Yves here. As we’ve mentioned, even some orthodox economists are questioning whether raising interest rates is a good tool to use against commodities scarcity/supply chain disruption induced inflation. The idea looks even worse in the Global South, where smaller/emerging economies get whipsawed by interest rate moves in the US. Given the potential severity of dislocations, even before getting to central banks administering the wrong medicine, we’ll be lucky if the worst we get is stagflation.

By Anis Chowdhury, Adjunct Professor at Western Sydney University and University of New South Wales (Australia), who held senior United Nations positions in New York and Bangkok and Jomo Kwame Sundaram, a former economics professor, who was United Nations Assistant Secretary-General for Economic Development, and received the Wassily Leontief Prize for Advancing the Frontiers of Economic Thought. Originally published at Jomo Kwame Sundaram’s website

“If your only tool is a hammer, every problem looks like a nail”. Still haunted by the clever preaching of monetarist guru Milton Friedman’s ghost, all too many monetary authorities address every inflationary threat or sign they see by raising interest rates.

Friedman’s dictum that “inflation is always and everywhere a monetary phenomenon” still defines the orthodoxy. Despite changed circumstances in the world today, for Friedmanites, inflation must be curbed by monetary tightening, especially interest rate hikes.

No central banker consensus

The threat of higher inflation has risen with Russia’s Ukraine incursion and the punitive Western ‘sanctions from hell’ in response. International Monetary Fund (IMF) Managing Director Kristalina Georgieva warns wide-ranging sanctions on Russia will worsen inflation.

European Central Bank (ECB) President Christine Lagarde fears, “The Russia-Ukraine war will have a material impact on economic activity and inflation”. US Treasury Secretary Janet Yellen has also acknowledged the new threat.

She recognizes tighter monetary policy could be contractionary, but expresses confidence in the Federal Reserve’s ability to balance that. Meanwhile, US Federal Reserve chair Jerome Powell has pledged to be “careful”.

Terming Russia’s invasion “a game changer”, with unpredictable consequences, he stressed readiness to move more aggressively if needed. On 16 March, the Fed raised its benchmark short-term interest rate while signalling up to six more rate hikes this year.

But other central bankers do not agree on how best to respond. Bank of Japan Governor Kuroda has ruled out tightening monetary policy. He recently noted, “It’s inappropriate to deal with [cost-push inflation] by scaling back stimulus or tightening monetary policy”. For Kuroda, an interest rate hike is inappropriate to deal with inflation due to surging fuel and food prices.

Friedman’s disciples at some central banks began tightening monetary policy from mid-2021. The Reserve Bank of New Zealand, the first to adopt strict inflation targeting in 1989, raised interest rates in August for the second time in two months.

The Bank of England (BOE) raised interest rates for the first time in more than three years in December. Going further, Norway’s central bank doubled its policy rate on the same day.

Anticipating interest rate rises in the US and under pressure from financial markets, central banks in some emerging market and developing economies (EMDEs) – such as BrazilRussia and Mexico – began raising policy interest rates after inflation warning bells went off in mid-2021. Indonesia and South Africa joined the bandwagon in January 2022.

Ukraine effect

With inflation surging after the Ukraine incursion, the Bank of Canada doubled its key rate on 2 March – its first increase since October 2018.

The ECB has a more hawkish stance, dropping its more cautious earlier language. Its governing council has reiterated an old pledge to “take whatever action is needed” to pursue price stability and safeguard financial stability.

Following the US Fed’s move, the BOE raised its interest rate the next day. A month before, in February, the BOE Chief Economist was against raising interest rates, favouring a more nuanced approach.

However, instead of kneejerk interest rate responses, Reserve Bank of Australia’s Governor Philip Lowe is “prepared to be patient” while monitoring developments.

EMDE central bankers have also responded differently. Brazil has raised its benchmark interest rate after the Fed, and signalled more increases could follow this year. But Indonesia has been more circumspect.

Interest Rate Not Inflation Cure-All

The interest rate is a blunt policy tool. It does not differentiate between activities facing rising demand and those experiencing supply disruptions. Thus, interest rate hikes adversely impact investments in sectors facing supply bottlenecks needing more investment.

In short, the interest rate is indiscriminate. But the prevailing policy orthodoxy of the past four decades does not differentiate among causes of inflation, prescribing higher interest rates as the miracle ‘cure-all’.

This monetarist policy orthodoxy does not even recognize multiple causes or sources of inflation. Most observers believe that current inflationary pressures are due to both demand and supply factors.

Some sectors may be experiencing surging demand while others are facing supply disruptions and rising production costs. All this has now been exacerbated by the Ukraine crisis and the ensuing sanctions interrupting supplies.

Old Lessons Forgotten

Well over half a century ago, the UN’s World Economic Survey 1956 warned, “A single economic policy seems no more likely to overcome all sources of imbalance which produce rising prices and wages than is a single medicine likely to cure all diseases which produce a fever”.

Addressing ‘cost-push’ inflation using measures designed for ‘demand-pull’ phenomena is not only inappropriate, but also damaging. It can increase unemployment significantly without dampening inflation, warned the UN’s World Economic Survey 1955 as Friedman’s anti-Keynesian arguments were emerging.

Interest rates do not discriminate between credit for consumer and investment spending. In efforts to dampen demand sufficiently, interest rates are raised sharply. Such monetary tightening can do much lasting economic damage.

Declining or lower investment is harmful for the progress needed for sustainable development, requiring innovation and productivity growth. After all, improved technologies typically require new machines and tools.

No One ‘One Size Fits All’

Dealing with ‘stagflation’ – economic stagnation with inflation – caused by multiple factors requires both fiscal and monetary policies working together complementarily. They also need particular tools and regulatory measures for specific purposes.

Monetary authorities should also create government fiscal space by financing unanticipated urgent needs and long-term sustainable development projects, e.g., for renewable energy.

Governments need to first provide some immediate cost of living relief to defuse unrest as food and fuel prices surge. This can be done with measures that may include food vouchers, suspending some taxes on key consumer products.

In the medium- to long-term, governments can expand subsidized public provisioning of healthcare, transport, housing, education and childcare to offset rising living costs. Such public provisioning – increasing the “social wage” – diffuses wage demands, preventing wage-price spirals.

Such policy initiatives brought down inflation in Australia during the 1980s without causing large-scale unemployment. This contrasted with the deep recessions in the UK and USA then due to high interest rates.

Get Correct Medicine

But to do so, governments need more fiscal space. Hence, tax reforms are critical. Progressive tax reforms – such as introducing wealth taxes and raising marginal tax rates for high income earners – also mitigate inequality. Governments also need to align their short- and long-term fiscal policy frameworks.

Monetary authorities need to apply a combination of tools, such as reserve requirements for commercial bank deposits, more credit, including differential interest rate facilities, and more inclusive financing.

For example, central banks should restrict credit growth in ‘overheated’ sectors, while expanding affordable credit for those facing supply bottlenecks. Central banks also need to curb credit growth likely to be used for speculation.

Governments also need regulatory measures to prevent unscrupulous monopolies or cartels trying to manipulate markets and create artificial shortages. Regulatory measures are also needed to check commodity futures and other speculation. These increase food and fuel price rises and other problems.

Relying exclusively on the interest rate hammer is an article of monetarist faith, not macroeconomic wisdom. Pragmatic policymakers have demonstrated much ingenuity in designing more appropriate macroeconomic policy responses – not only against inflation, but worse, the stagflation now threatening the world.

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  1. Louis Fyne

    magically, The Ukraine War made all the US culture war headlines go away.

    Maybe it’ll take 15% annual inflation for a bottom 85% class consciousness to emerge.

    only then can you have things like estate tax reform, etc.

    not holding my breath

    1. digi_owl

      Doubt it. More like they have something more “awesome” to distract with than toilet door squabbles. Now the masses can go “orc hunting” rater than worry about how to pay for fuel and food.

      1. Anon

        Interested to hear what the problem is. Hoping you say lizard people. Not really, but I’m burned out on econ0mics, could use a new narrative… something a bit less intellectual, yet still more credible than the status quo…?

    2. Larry

      Not really. It’s alive and well with the supreme court nomination process. I do agree that the war has risen to the top of headlines, but the culture wars are below the fold and much higher on people’s minds if non MSM media narratives are an indication.

  2. marku52

    Nah it’s still there. De Santis is preventing a trans gender swimmer from getting a medal, some other red state is doing the same.

    Still the meme whiplash is impressive. We’ve gone from:
    Orange Man Bad
    Pandemic of the Unvaxxed

    The mighty Wurlitzer pivots on a dime and speaks with a single voice. Orwell would be so proud.

    PS. Maybe we are done with Horse Paste too.

    1. paul

      Correction: De santis is preventing a fully intact male, if mediocre, competitor from receiving a medal designed to reward a fully intact female.

  3. Glossolalia

    We need some more polls telling us how willing citizens are to suffer for the war in Ukraine.

    – Are you willing to pay $7 a gallon for gas?
    – Are you willing to not be able to afford a vacation this summer?
    – Are you willing to see the value of your home drop as interest rates rise?
    – Are you willing to die in a nuclear war?

  4. juno mas

    Inflation beats up most people most of the time. Low interest rates hurt retirees and inspire Wall Street while favoring younger folks (if they can overcome wage stagnation) and student debt. This is the conundrum (precarity) that divides the US. The solution is not what should be the interest rate, but implementation of programs (progressive taxation, government regulation, etc) that will reduce the precarity of life in the US.

    1. aj

      agreed. I’m kind of in agreement that there should be a low-risk investment vehicle that returns somewhere like 3-5% which would help retirees and those on fixed incomes, help keep asset prices (e.g. stocks and housing) steadier, and help to contain some of the riskier Wall Street investments.

      The problem is that you’d have to move from current rates to 3-5% and it’s just impossible to make that big of a jump without causing major collateral damage. They dug themselves into a hole with low rates and it would take actual leadership to pull us out of it. Something that our elected officials are wholly incapable of.

    2. cobo

      Actually, all seems to be working quite well. In the snapshot of the past two years, many small businesses were broken by the forced business closures. At the same time, massive amounts of fantasy money was awarded to the wealthiest individuals and institutions to continue hoovering up the assets of those again broken by economic catastrophe over which they had no control. And now, interest rate hikes will make it impossible for small businesses to invest in the opportunities that the wreckage of an insane global supply chain has allowed. I would call it a perfect storm, but there’s always a way to explain how everything just continues to go down the drain.

  5. Roquentin

    I most agree with this, particularly on advocating higher progressive income tax rates at upper margins as a more precise way to combat inflation. That said, I feel like the elephant in the room is basically being ignored for a chance to dunk on Friedman and the Chicago school (as satisfying as that feels). That elephant is the fact we’ve undergone QE basically since 08 and that created the situation we’re in now as much as war, COVID, or anything else. The Fed finally stopped MBS purchases within the last month, you can’t claim the low interest rates weren’t a direct contributor to the current real estate bubble. I am no fan of Friedman, but up to a point this inflation is a monetary phenomenon.

    You can’t have it both ways, have perpetual QE and ZIRP, and then say inflation isn’t a monetary phenomenon, caused by external economic factors.

    1. Jung

      The fed policies since 2020 have been more or less unprecedented if you compare the federal fund rate to CPI inflation for example.

      1. Roquentin

        I agree completely. I think it’s a little disingenuous to act as if monetary policy isn’t big contributing factor to the mess we’re currently in. It may not be all of it, but to act like it’s not involved…

    2. Oh

      Yes. Add to that the greed of speculators and large corporations. First they blamed the supply chain, now Ukraine situation.

  6. Jung

    The inflation was present before the war, in no small part being a symptom of monetary policy. But even this was in reality a reflection of the fact that policy wanks have only one scripted response to economic shock: “The working class must make a great sacrifice for the greater good as we inflate asset prices relative to their sticky wages.” Improving efficiency by reducing rents and prioritizing critical industry through rationing would have been more rational.

  7. digi_owl

    I stick to my thinking that stagflation came about because UK economists liberalized credit (in particular the new idea: credit cards) in order to goose domestic economic activity. But the politicians refused to follow up by devaluing the pound, and thus credit ended up replacing wages and shit spiraled from there as imports killed what remained of domestic industry after the war.

  8. p fitzsimon

    I’m one of those retired on a fixed income. I recently opened a savings account that pays .1% interest. Given inflation of 7+% isn’t that a wealth tax of 7%?

    1. Jung

      Inflation makes assets like real-estate, stocks, and bread prices go up while wages stay put. If you’re mostly gambling on assets or making money from other peoples work this makes your profits go up. Actually the better part of the reason central banks decrease interest rates during recession is because this effect gives business cheaper wages and higher profits which encourages them to invest. It’s the exact opposite of a wealth tax.

      1. p fitzsimon

        The situation that we have now is high inflation with very low interest rates and wages that are increasing but not enough to keep up with inflation. In the 70s we had high inflation, high interest rates that reached almost 13% on short term govt bonds by 1980 while median household income doubled in that period.

        1. Jung

          So far as I can tell real wages declined in the 70s while real median household income stagnated (most graphs of the second don’t include data from the 70s). The latter would have to be due to people working more hours or more women entering the work force.

          1. p fitzsimon

            Median household income kept up with inflation (which I guess is stagnation). Median personal income increased at less than inflation. Having worked through that era keeping your job or finding one was the big concern.

            1. Jung

              Seems like I should have said real wages decline in my first reply while stating real prices stay the same, and then we wouldn’t have disagreed. Sorry about that.

      2. aj

        Low interest rates cause asset inflation (stocks, housing) as investors look for riskier things to place their money in since they can’t get decent returns from relatively risk-free investments like Treasury Bonds.

        Interest rates have very little effect on commodity prices (bread, milk, shoes, etc.) as any additional cost in credit translates to only small price increases passed on to the consumer. People aren’t buying more bananas because credit it cheap. What typically drives commodity inflation are supply shocks, which is what we are seeing now with covid shutdowns of factories and trade issues with Russia and China.

        The fact that traditional economics treats these things as the same is confusing and wrong, but that seems to be the point.

        1. Jung

          Lowering interest rates also increases the amount of money in circulation especially through fractional reserve banking etc. If you increase money in circulation without an equivalent improvement in production you’re going to erode purchasing power of the dollar.

          1. aj

            Fractional reserve banking is a myth. Even the Bank of England is willing to admit it. link

            Under the currently system, all money is created by loans (it’s literally a liability on someone’s balance sheet). Low interest rates create more demand for loans, but those dollars that are created end up chasing assets like stocks and housing because you only need so many commodities. The demand for shoes isn’t really driven by interest rates, whereas the demand for home loans and stocks is.

            It all comes back to who gets the money and what do they use it for. There’s lots of little nuance going on that everyone just ignores. There are losers and winners in every policy, “the economy” is not a monolith and “economists” tend to be the first people to ignore that fact.

            1. Jung

              So an icecream cone doesn’t cost 5 cents anymore or whatever because there is more money than there once was right? You say all money is created by loans, and low interest rates create more demand for loans (and specifically the type of loan which increases the money supply). Lower interest rates then imply more money which then implies more expensive ice-cream cones.

              1. aj

                Rising prices are a function of our current form of capitalism. Firms face a constant pressure to increase profits and grow exponentially. Firms raise prices when they can to maximize margin %. Prices aren’t determined entirely by supply and demand because we don’t have perfect competition. So, like what we are seeing currently is input prices going up (e.g. gas) and firms pass that along to their customers along with an added profit margin. Is it the money supply driving the majority of these price increases, or input costs and greedy firms?

                I do admit that I tend to exaggerate sometimes when trying to make a point. I don’t claim that the money supply doesn’t drive price increases, just that it is not the primary driver in a lot of cases it gets blamed for. FYI, the current form of capitalism doesn’t work with some moderate price increases over time. If asset prices didn’t increase, the stock market never went up, etc. the whole system falls apart. None of that is possible without “inflation”

        2. Mike

          Money begets more demand. I work for a large general contractor. In 2 years our job costs are up 30%, are we building 30% less? No. None of our projects have cancelled, all of our developers continue to push through and build because they are awash in money. We have more demand than ever…sure we have shortages but that is not stopping anybody, the money side seems way more potent in this situation.

  9. QuicksilverMessenger

    I am in the spice and specialty food business and we bring in a fair amount via import- stuff you literally cannot get here, and/or does not grow here. It’s a very old trade of course, just different delivery now days.

    I can report that bringing in a 20′ container (I’m on the West Coast) used to average about $3 to $4,000 for import, dray, chassis etc.

    The bills for the last 5 containers have all been about $23,000. Each.

    All of the extra fees are from Demurrage and Detention charges that go to the shipping lines and terminals. Kaching! This is almost all due to back ups in the ‘supply chain’ and an inability to clear and move containers. So they sit at various staging areas (on the ship, at the Terminal, at the marshaling yards, waiting for chassis, drivers, whatever) all the while racking up big fees.
    It’s free money for them and so have absolutely no incentive to change any of this. But it will cost everyone in the country more and more money as these costs will all get passed along

  10. Brick

    It feels like a long term trend is beginning to reverse and strategies probably need to be the opposite of those in the past. Long supply chains, abundant cheap raw materials, throw away resources seem like trends with limited life expectancy. Current stagflation seems like the initial upheavals of a reversal of trends.

    Targeting credit control, wage increases, reducing cost may be tools that will not work as well in the future. Maybe looking at increasing workers rights and tariffs based on these, or increasing product longevity through mandated warrantees, providing grants and under writing parts of investment would help. The strategies ingrained into most politicians and business leaders are in complete contrast and you can perhaps begin to understand the attraction for politicians who threaten to throw out the current rule book.

    Think we have a more fundamental problem than central bank policy and I am not sure we have politicians up to the job.

    1. Jeremy Grimm

      The u.s. Populace does not face stagflation. Stagflation is a ghost from the Carter years. This is a blatant play by those with power to queer explanations of what is happening.

  11. Katniss Everdeen

    Tweet highlighted last night by Tucker Carlson which sums up the situation pretty well IMNSHO:

    You’re watching a master level Ponzi scheme. 2020 crash gets laundered through covid bailouts. Covid bailouts laundered through inflation. [me: and “supply chain disruptions”] Inflation laundered through war in Ukraine. The war and its effects on the globe will be laundered through climate change. The perps walk.

  12. Dave in Austin

    I’m sensing a real disconnect between the policy suggestions and the speed of the economic disruptions. We are eight months before an election so fiddling around with the tax code while the economy burns is a non-starter. We are stuck with the tools we have.

    I see no indication that the administration consulted the economic and fiscal world before committing to the Ukraine and announcing the extraordinary sanctions. Was this staffed-out or did it come out of a few people in the West Wing? If anyone on NC has any insight into not only how the sanctions decisions were staffed but also how- or if- the secondary effects on the economy, the inflation rate and the supply chain were taken into account, please comment.

    So far I see no indication that this decision was anything other than an ad hoc reflex.

    The time line I see is the Russians invaded expecting to stage a relatively non-violent military demonstration at the undefended gates of Kiev to be followed by a quick armistice. On the fourth day we offered Zelinskyy a free ride out. Against all “rational” expectations, he refused, at which point the real war began, the US moved to extensive “kitchen sink” sanctions, loosed the Press Hounds of War and Zelinskyy dug in. I see no indication that the sanctions were staffed and role-played at all.

    Again, if anyone on here has more information on the decision-making in DC, please chime-in.

  13. Halsey Taylor

    I remember stagflation. What was different then is there wasn’t a Fed who pumped money to the wealthy via a formal ‘wealth effect’ doctrine.

    As inflation hits, it might knock an ivory back scratcher or two from some upper income shopping lists. The rest of us will take it in the shorts. But as both parties have shown over the last 40 years, that won’t matter.

    But, that’s OK. We have wokeness.

  14. timbers

    If look at actual real inflation (hint: include financial assets and housing) Milton Friedman’s dictum that inflation is always and everywhere a monetary phenomenon looks like the most airtight rule of economics I can think of. But we don’t include those real actual components, and so we have reported low inflation rates when actual rates were/are much higher. Not defending him just saying how I see it. Also interest rates should be raised not only to fight inflation – and raising them absolutely will fight home and assets inflation – but also to normalize the economy and stop subsidizing asset holders.

    1. Canadian Canuck

      Friedman isn’t liked much around here but he was one of the most rigorous economists to have ever lived. His analysis of inflation is spot on and have not been invalidated.
      He saw where the system was going and fought hard to have a balanced budget amendment in the constitution but unfortunately it didn’t gather 2/3 of votes despite wide bipartisan support.
      We certainly won’t be in this hole if such amendments would have passed.

      1. Yves Smith Post author

        No, that is absolutely false. His monetarist theories were decisively disproven by monetarist experiments during the Reagan/Thatcher eras. Changes in money supply correlated with NO macroeconomic variable, including on a lagged basis.

        And his theory that money supply expansion produces inflation was again decisively disproven by Japan, which massively expanded its money supply yet has barely been able to get out of deflation.

        Friedman also believed in the loanable funds theory, another load of crap.

        Both Walter Heller (Johnson admin member) and Friedman predicted the Johnson refusal o raise taxes when engaging in what amounted to fiscal stimulus when the economy was at full employment shows would create inflation means resulted from fiscal activity (too much demand relative to the economy’s productive capacity) which was NOT a monetarist observation. And it was made much worse by the oil price shock, again not a money phenomenon.

        Go read Steve Keen for a long form debunking of Friedman, or a shorter form in ECONNED. He was a brilliant ideologue but not much of an economist, and a destructive force at that.

        1. Bellatrix

          No, not absolutely false, and your specific example regarding Japan is illustrative of why. The massive monetary expansion in Japan followed the collapse of one of the most extraordinary booms in human history, particularly in real estate. I recall reading that the value of the Royal Palace exceeded the value of all the land in California and prices for simple items like a cup of coffee or an apple were ridiculously high. Without intervention, a collapse of that magnitude would have resulted in a deep and perhaps unprecedented depression, with massive deflation. Massive money printing averted that outcome and resulted in a a significantly more mild, but greatly prolonged recession, rather than a depression. Reducing deflation and producing inflation are the same effect, so the Japanese experience does not disprove Friedman’s monetarist theories at all.

          1. skippy

            Then why was Milton almost 6k% off on his GBP bet. Yet the umbrage is not about money at the end of the day but how people use it, create it, and end contracts with it, and not about its intrinsic value on this day.

          2. OnceWereVirologist

            Friedman’s thesis was that inflation was everywhere and always a monetary phenomenon, i.e. an increase in the money supply above the economy’s output produces a proportional increase in prices. If you’re admitting that that isn’t the case, as in the Japanese example, then you’re admitting that the theory is wrong. The Japanese experience has been disproving Friedman not just in the aftermath of their real estate crash but continuously over the last 30 years.

            1. Bellatrix

              No, I think you’ve missed my point. The credit contraction caused by the bust was highly deflationary and the credit expansion due to money printing was inflationary. They at least partially cancelled each-other out, avoiding a depression (which was the objective) and resulting in relatively mild overall deflation and a more orderly decline in stock and real estate prices. Taking the slow approach stretched the adjustment process out to 20 or so years, but avoided a massive deflationary depression.

              Japan’s inflation rate has generally been lower than the other developed economies for the past 30 years. I would suggest that for the first 20 years that was at least partially due to the above adjustment process, but for the last decade has more to do with Japan’s ageing and now declining population, which is the oldest in the world.

              I think it’s a very long stretch to use the quite unique Japanese experience to debunk Friedman’s theories.

              1. Basil Pesto

                but for the last decade has more to do with Japan’s ageing and now declining population, which is the oldest in the world.

                That’s quite the straw-clutch

                1. Bellatrix

                  And your explanation for why Japanese inflation has been lower than in other developed economies is?

              2. OnceWereVirologist

                Now you’re arguing that persistent low inflation in Japan is a sociological phenomenon, i.e. not a monetary one. Your own words contradict Friedman’s theories. If Friedman’s theory doesn’t apply in an aging population, after a real estate crisis, or in a recession, then its a worthless theory. You can’t just make ad hoc exceptions to a theory when its results don’t match its predictions.

                1. Bellatrix

                  You still don’t get it! None of them is an ad hoc exception! Remember Isaac Newton? If one force acts in one direction and another force acts in the opposite direction they cancel each-other out and what you see is the net effect! If they cancel each-other out perfectly, nothing happens, but that doesn’t mean neither force exists.

                  Sociological phenomenon like population decline and national ageing have an impact on production, income, saving, spending, consumption, taxation, social security etc. etc., so they obviously have a monetary impact and are generally seen to be deflationary on balance.

                  The whole point of government intervention is to affect other forces that are at work in the economy (to reinforce, or oppose) and what we see is the net outcome. In Japan, I strongly suspect that without massive QE over the last 30 odd years deflation would have been much greater, so there is no repudiation of Friedman here.

                  1. OnceWereVirologist

                    Exactly, sociological phenomenon like population age distribution, and economic factors, like the point in the business cycle or the income distribution affect the velocity of money. Friedman made the assumption that velocity is constant in order to derive his theories. If it’s not, the theory is worthless.

                    And as an aside, there are no forces in an economy in the sense of physical forces. There are only the decisions of individual actors. Conceptualizing the decision of a collection of individuals to spend or to save as opposing physical forces doesn’t in any way correspond to the underlying physical reality. You’d do as well to make an analogy to Freud as to Newton, because psychology has a lot more to do with inflation and deflation than physics does.

                    1. Bellatrix

                      Making an assumption does not of itself render a theory worthless, unless it can be so demonstrated, which I don’t think is the case here.

                      As to your aside, my point is not that the forces are physical, but that they can cancel each-other out, so what may appear relatively benign on the surface may be the net result of powerful and opposing underlying forces.

          3. PlutoniumKun

            The Japanese experience absolutely debunked Friedman. Long after the initial crash the Japanese central bank has desperately tried to stoke some inflation through monetary expansion and failed multiple times.

            I’d also point out that Yves was there at the time and knows far more about 1980’s Japan economics than anyone here.

              1. c_heale

                See above isn’t an argument. Yves is correct esp. in the case of the UK. All Friedman’s grandiose nonsense was comprehensively debunkedin the 1980’s. I grew up in that time and watched the destruction of British industry and the beginning of the financialization of the economy.

                The physiocrats were correct, not Friedman.

                1. Bellatrix

                  My “See above.” comment is a reference to my immediately preceding reply to OnceWereVirologist, which covered the same point.

                  As to Friedman, we will just have to disagree about that. I am no fan of ‘the financialization of the economy’ and see it as the culmination of 60 odd years of poor economic management, both fiscal and monetary, which is sure to end badly.

                  1. BlakeFelix

                    I think that the BOJ just didn’t try hard enough to create inflation if they wanted it. Negative interest rates are stupid, IMO, but they might have been inflationary. A UBI would be much more efficient for fighting deflation without causing the perverse nonsense of paying people to borrow. I think that since inflation is the loss of money’s buying power, it’s hard to say that it’s not a monetary phenomenon. If Friedman assumed velocity was constant that is obviously goofy to expect in the real world. The equation is Velocity equals GDP/Money Supply. Yves is right that money supply is fuzzy, and loanable funds isn’t it and I don’t know what it is. Still, I feel that printing money and lowering interest rates on government guaranteed debt increases the money supply, whatever it is. A Carbon Tax seems like the clear anti inflation choice to me, since that would help address both inflation and climate change.

    2. Mike

      I don’t think interest rates will rise to the level people think. I think this is less like the 70/80’s and more like coming out of WW2 where they will just let inflation run hot so everyone, including the government, can afford to service their debts. Just my assumption, my crystal ball is cracked anyways.

      I think per Yves comment below what is really shown is that economists in general subscribe to a field that is bunk science. Most approach their field, including Friedman as if you can always pull a lever X and get some amount of Y. Really what happens is you pull a lever X, get some Y and then 5 other variables are effected to some degree. It is always a multivariate equation that probably requires computational modeling well beyond what they are used to. If people don’t believe me then show me where economists have been able to predict anything accurately in the past, i don’t know, forever? We give them way to much influence. A whole society following the FED, driven by a field that can’t predict what they claim, imagine that?

      In Friedmann’s defense, I don’t think this author has actually grasped his work. Friedmann never said to just raise interest rates in response to inflation. One of his basis premises was there was a massive yo-yo effect from the late 60’s through the 70’s of interest rate adjustment without ever changing the actual printing of the money. It’s that swing back and forth that is dangerous, and clearly in the 70’s each time it swung back and forth it got worse.

      The author states “In the medium- to long-term, governments can expand subsidized public provisioning of healthcare, transport, housing, education and childcare to offset rising living costs. ” Friedmann would roll his eyes at that, because government spending without a balanced budget is inflationary, generally. I think Yves comment about the Reagan era is trying to disprove that but I think it may be shielded by the reinforcement of the dollar in the foreign markets. But who knows again I think economists at large can’t predict what they can claim. There always the next “theory” being pushed, mean while every other scientific field continues to build on what they previously learned.

  15. Sound of the Suburbs

    What do we think a central bank is supposed to do?
    Control the economy and inflation with monetary policy.

    What is a central bank actually supposed to do?
    1) Ensure the economy has the stable money supply it needs
    2) Backstop the financial system

    The FED did eventually remember what they could have done in the first place after 2008.
    In the US, the Government loaned the banks the money with onerous conditions attached, and the bankers weren’t very happy with these onerous conditions.
    The FED eventually remembered what they could have done in the first place and started to take all those toxic assets off US banks at full value with money they created out of nothing.
    The US banks could pay back their loans and get back to normal, without all those onerous conditions.

    Ensuring the US economy has the stable money supply it needs has proved very difficult as no one seems to understand the monetary system.
    It’s a debt based monetary system and you need to ensure the debt within the system stays at acceptable levels.

    Luckily the Americans had the Great Depression It cleared the slate, and allowed them to continue in the usual haphazard manner to which they have become accustomed.
    At 18 mins.
    They need to clear the slate again. Raising interest rates with all that debt in the economy could be dangerous move, but they won’t know that.

    Japan has got a much better understanding of debt deflation than we do.
    They have been fighting debt deflation since 1991, when they saved the banks and left the debt in place after their financial crisis.

    1. Sound of the Suburbs

      How does the capitalist system actually work?
      I am trying to find out and it isn’t easy.
      I have already put the foundations in place, which will be very useful.

      How do the basic elements of the system fit together?
      GDP measures the new goods and services being produced in the economy every year.
      This is where the real wealth in the economy lies.

      Private banks create the money supply.
      Money and debt come into existence together and disappear together like matter and anti-matter.
      Bank loans create money and debt repayments to banks destroy money.
      Bank loans create 97% of the money supply
      The money supply ≈ public debt + private debt
      Money and debt are like opposite sides of the same coin.

      The money supply should grow with the economy, i.e. GDP.
      More goods and services in the economy require more money in the economy.

      It’s a debt based monetary system.
      You want the debt to stay at a level where it will not adversely affect the economy.
      You want GDP, the money supply and debt to grow together so the economy is not held back by the debt contained within it.

      How do you achieve this?
      The idea is that banks lend into business and industry to increase the productive capacity of the economy.
      Business and industry don’t have to wait until they have the money to expand. They can borrow the money and use it to expand today, and then pay that money back in the future.
      The economy can then grow more rapidly than it would without banks.
      Debt grows with GDP and there are no problems
      The banks create money and use it to create real wealth

      When you have a firm grip on what money and wealth really are; and know how banks work, it all falls into place.

      Neoliberalism is a top down ideology, and when you get to the base you find there are no foundations.
      I think a bottom up approach is the way to go; now we have some solid foundations.

      1. Bellatrix

        That’s pretty good!

        Here is a link to a 30 minute YouTube video made by Ray Dalio that does a good job of explaining how an economy works in quite simple terms:

        Most of it is relevant to any economy and it tracks through what causes growth and economic cycles. I hope it’s useful.

          1. Bellatrix

            So sorry about that. I’m not sure why it doesn’t work from the comment because it works when I cut and paste it and also when I paste the shorter version starting from youtube…etc.

            Try that and if it still doesn’t work just search for “How The Economic Machine Works by Ray Dalio” on YouTube.

      2. c_heale

        Where do energy and resource limits fit into this? A theory without these factors is bunk.

        1. BlakeFelix

          I think that, kind of loosely put, they effect the supply, and money effects the demand, and prices and therefore inflation are reflected at the intersection of supply and demand. So if there isn’t enough food to go around monetary policy can’t stop people starving, but money can effect the distribution of who eats and how much, and the price levels at which some people can’t buy food. Food can be unaffordable at low prices, like in the depression, or at high prices, like Weimar or Venezuela. That part is a monetary phenomenon. Energy is similar to food, it’s a hard constraint, but under current circumstances squishy enough that more production can relatively easily be bought with money.

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