How to prevent and cure inflation. (It’s not what the “experts” tell you.)

Two related philosophies about federal finances are MMT (Modern Monetary Theory) and MS (Monetary Sovereignty). You now are reading an MS blog.

MMT and MS agree on the following principle that was expressed by MMT’s L. Randall Wray in his paper “WHAT ARE TAXES FOR? THE MMT APPROACH” 

“Taxes are not needed to ‘pay for’ (federal) government spending. The logic is reversed: government must spend (or lend) the currency into the economy before taxpayers can pay taxes in the form of the currency. Spend first, tax later is the logical sequence.”

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The U.S. government cannot run short of dollars.

U.S. federal taxes are not needed. The U.S. government, being Monetarily Sovereign, has the unlimited ability to create its own sovereign currency, the U.S. dollar.

The U.S. government never unintentionally can run short of dollars. Even if all federal tax collections totaled $0, the federal government could continue spending, forever.

The articles you read about the “unsustainable” federal debt are, very simply, wrong. There is no level of U.S. dollar obligations the federal government cannot easily sustain.

Ben Bernanke: “The U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost.”

Alan Greenspan: “Central banks can issue currency, a non-interest-bearing claim on the government, effectively without limit. A government cannot become insolvent with respect to obligations in its own currency.”

St. Louis Federal Reserve: “As the sole manufacturer of dollars, whose debt is denominated in dollars, the U.S. government can never become insolvent, i.e., unable to pay its bills. In this sense, the government is not dependent on credit markets (borrowing) to remain operational.

Professor Wray’s paper continues:

Some who hear this for the first time jump to the question: “Well, why not just eliminate taxes altogether?” There are several reasons.

First, it is the tax that “drives” the currency. If we eliminated the tax, people probably would not immediately abandon use of the currency, but the main driver for its use would be gone.

We disagree with the “taxes drive the currency” notion. Contrary examples abound. Professor Wray’s own “Roobucks” are not “driven” by taxes. They are driven by the discounts they provide. Bitcoin is not “driven” by taxes.

However, the real point is contained in the following paragraphs from Wray’s paper:

Further, the second reason to have taxes is to reduce aggregate demand. If we look at the United States today, the federal government spending is somewhat over 20% of GDP, while tax revenue is somewhat less—say 17%.

The net injection coming from the federal government is thus about 3% of GDP. If we eliminated taxes (and held all else constant) the net injection might rise toward 20% of GDP.

That is a huge increase of aggregate demand, and could cause inflation.

Ideally, it is best if tax revenue moves countercyclically—increasing in expansion and falling in recession.

That helps to make the government’s net contribution to the economy countercyclical, which helps to stabilize aggregate demand.

The implicit assumption of the above paragraphs is that the private sector’s money supply drives inflation, and the way to control inflation is to reduce the private sector’s money supply.

In a similar vein:

A Wikipedia article says, “Low or moderate inflation may be attributed to fluctuations in the real demand for goods and services, or changes in available supplies such as during scarcities. However, the consensus view is that a long sustained period of inflation is caused by money supply growing faster than the rate of economic growth.”

We disagree with Wray and with the Wikipedia author. A “long sustained period” of money supply growth cannot exceed a “long sustained period” of economic growth.

The money supply cannot grow faster than economic growth. The two are interdependent in the formula for GDP:

Real GDP = Real Federal Spending + Real Non-federal Spending + Real Net Exports

A decrease in taxes would increase the “Non-federal Spending” factor and GDP by the same amount. By formula, tax decreases increase GDP.

Inflation usually is defined as a general increase in prices. Another way to say it is, “Inflation reduces the purchasing power of each unit of currency.”

There are two levels of inflation: Intentional and unintentional. The intentional form is the amount that the central bank believes is helpful for a growing economy. The U.S. Federal Reserve has as its target rate, 2% inflation.

When annual inflation drifts above or below the 2% target, the Fed quickly raises and lowers interest rates, i.e. raises to rates combat inflation; lowers rates to stimulate inflation.

(The Fed also lowers interest rates to stimulate economic growth, which follows the common myth that stimulating growth and stimulating inflation require the same actions.)

The Fed’s target rate of inflation is maintained by interest rate control, which controls the demand for, and purchasing power of, U.S. dollars. Increasing the demand for dollars reduces inflation; decreasing the demand for dollars encourages inflation.

But what about high inflation, say of 50% or 50,000% annually or more. Such hyperinflations always are caused by shortages of food and/or energy (oil).

The famous Zimbabwe hyperinflation is a typical example. The government took farmland from white farmers and gave it to blacks who did not know how to farm. The inevitable food shortage caused hyperinflation.

In response, rather than trying to cure the food shortage, the Zimbabwe government began printing more currency.

This provided the illusion that currency printing caused the hyperinflation, when in fact, the hyperinflation caused the currency printing.

Think of a typical scenario this way: The inflation-adjusted money supply goes up. Where does the additional real money go? The vast majority goes to spending, which by definition, increases real GDP.

One might argue that some is saved, but since saved dollars are not spent, they cannot contribute to aggregate demand.

All increases in the real money supply increase real GDP.

Further, and most importantly, all decreases in the real money supply (because of taxes) decrease real GDP. Thus taxes, rather than being effective moderators of inflation, actually are recessive.

Recession is not the opposite of inflation. The two can occur simultaneously. The opposite of inflation is deflation. Taxes do not cause deflation. Deflation, i.e. price decreases, is caused by excess supplies of goods and services.

Thus, removing currency (via taxes) from the economy would have done nothing to cure the inflation, though it would have reduced real (inflation-adjusted) GDP economic growth, while it impoverished the populace.

There are several ways to prevent or cure inflation, but taxation is not one of them. Taxation merely takes dollars from the private sector and delivers them to the federal government, where your tax dollars are destroyed.

Taxation does nothing to address the fundamental cause of inflation: Shortages.

Imagine an inflation caused by a food shortage, and the automatic response is an increase in taxes. How would leaving fewer inflation dollars in the pockets of the people eliminate the food shortage?

It wouldn’t, of course.

Consider again, Zimbabwe: Rather than taxing, designed to reduce the currency supply (while impoverishing the people), or printing currency to increase the currency supply (thereby reducing the already diminished value of Zimbabe’s money), the Zimbabwe government should have taken steps to increase the food supply.

This might have included paying to educate Zimbabwe’s farmers and/or paying experienced farmers to manage farms or paying to import food from other nations.

These steps would have required the Zimbabwean government to spend more money to correct inflation — a counterintuitive response, but the only one based on financial reality.

In Summary
Any time a nation experiences an unwanted level of inflation, the correct early step is to increase interest rates, thus increasing the demand for, and the value of, the nation’s currency.

If the inflation has grown beyond interest rate increases as a sole solution, additional steps are needed:

  1. Determine what exactly is causing the inflation
  2. If the cause is a shortage of food or energy the government must either import the needed food or energy, or fund ways to increase the domestic production of food or energy.
  3. If the government is monetarily non-sovereign (a euro nation, for instance), and cannot afford to fund imports or fund domestic production of the scarce commodities, it immediately should begin the process of issuing its own sovereign currency, i.e. it should make itself Monetarily Sovereign.

Raising taxes is exactly the wrong step since that will worsen the inflation problem, while adding recession to the burden.

Rodger Malcolm Mitchell
Monetary Sovereignty
Twitter: @rodgermitchell
Search #monetarysovereignty Facebook: Rodger Malcolm Mitchell

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The most important problems in economics involve:

  1. Monetary Sovereignty describes money creation and destruction.
  2. Gap Psychology describes the common desire to distance oneself from those “below” in any socio-economic ranking, and to come nearer those “above.” The socio-economic distance is referred to as “The Gap.”

Wide Gaps negatively affect poverty, health and longevity, education, housing, law and crime, war, leadership, ownership, bigotry, supply and demand, taxation, GDP, international relations, scientific advancement, the environment, human motivation and well-being, and virtually every other issue in economics.

Implementation of Monetary Sovereignty and The Ten Steps To Prosperity can grow the economy and narrow the Gaps:

Ten Steps To Prosperity:

1. Eliminate FICA

2. Federally funded Medicare — parts a, b & d, plus long-term care — for everyone

3. Provide a monthly economic bonus to every man, woman and child in America (similar to social security for all)

4. Free education (including post-grad) for everyone

5. Salary for attending school

6. Eliminate federal taxes on business

7. Increase the standard income tax deduction, annually. 

8. Tax the very rich (the “.1%”) more, with higher progressive tax rates on all forms of income.

9. Federal ownership of all banks

10. Increase federal spending on the myriad initiatives that benefit America’s 99.9% 

The Ten Steps will grow the economy and narrow the income/wealth/power Gap between the rich and the rest.

MONETARY SOVEREIGNTY

13 thoughts on “How to prevent and cure inflation. (It’s not what the “experts” tell you.)

  1. I completely agree with your overall conclusion; however, I think your implicit assumption regarding Professor Wray’s comments may be somewhat misrepresenting his position regarding elimination of taxes. The inflation concern is not so much about increasing money supply in the PS, but rather increasing aggregate demand as a direct result of government spending competing for resources. He also does not state whether inflation would occur, only that it could occur, presumably depending on whether or not the economy was at full employment, which is a standard position of MMT.

    MMT states that while the government has the unlimited ability to spend money, it cannot do so without consequence, and that consequence would be higher inflation and interest rates.

    Also, while taxes are not necessary to drive certain forms of money, like Bitcoin or Roobucks, they are necessary to drive government issued, non-convertible fiat currency, which is a prerequisite for being monetarily sovereign. Governments using currency that relies on convertibility, scarcity, or discounts to drive demand would not be considered monetarily sovereign.

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    1. “ . . . could occur . . .”
      Is that identical to “might occur” and “might not occur” and “I have no idea whether or not it would occur”?

      “ . . . that consequence would be higher inflation and interest rates.”
      In 2008 the federal debt held by the public was $5 Billion. This year it is $16 Billion, more than 3.00 fold in only ten years. So where is the higher inflation and interest rates? What level of increase would cause “higher inflation and interest rates”?

      “ . . . they are necessary to drive government-issued, non-convertible fiat currency, which is a prerequisite for being monetarily sovereign.”
      Why?

      So far as government spending competing for resources, government spending also adds resources. Ask the soybean farmers.

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      1. Might or might not occur depends on the conditions within the economy.

        Federal debt is money held in T-Accounts and is not part of the money supply and cannot chase goods and services, so it has no relationship to Demand Pull inflation. MMT has never argued that money supply causes inflation (that was Milton Friedman and the Chicago School), they argue that competition for resources by excessive government deficit spending can cause inflation depending on the level of slack in productive output.

        If the PS is consuming 95% of the the productive output and Government wants to take 20% of the output for public purpose without reducing the purchasing power of the PS, how would that not cause inflation (at least initially)? The only time in recent history this was ever a concern was during WWII, hence the sale of war bonds that deferred PS spending to keep control inflation.

        There is a long history of governments using taxes to drive acceptance of of currency and I know of no examples of successful government issued currency not held up by taxes. When you can provide me an example of a Fiat currency that works without taxes let me know.

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        1. Here are some examples: http://mentalfloss.com/article/55414/7-cities-have-their-own-currencies

          By the way, all currencies are “fiat,” in that they are created by the creating agency’s fiat. The use of the term “fiat” to describe money is a redundancy.

          Definition of fiat
          1: a command or act of will that creates something without or as if without further effort
          According to the Bible, the world was created by fiat.
          2: an authoritative determination
          3: an authoritative or arbitrary order: government by fiat

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          1. Indeed, fiat currencies can exist without taxes. There is likely a kernel of truth that the existence of taxes will effectively compel the use of that particular currency more so that competing currencies, but even then, only a token amount of taxation is sufficient.

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          2. Thanks for the examples but my main problem with these currencies is they are all convertible or pegged to government currency so they are not true fiat currencies by MMT definition, which have floating exchange rates and make no promise about convertibility. While I agree they are definitely money in all respects, the issuing authorities are not Monetarily Sovereign. The whole point about this blog, and the underpinning of MMT, is the fact that the U.S. is Monetarily Sovereign, so I am still not convinced of your logic equating US currency to local and digital currencies. I guess we can just agree to disagree on this issue.

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          3. Actually, they are not all convertible to a government currency. Wray’s own currency is not convertible or pegged to anything.

            Anyway, the “driving” verb is meant to indicate that without taxes, there would be no demand for a currency, and I gave you examples indicate this simply is not true.

            Wray is trying to show that without taxes, the demand for U.S. dollars would disappear (He even says it), and I see no evidence that is even remotely true. While taxes may add to demand, that is not what Wray says.

            I gave you examples of money without taxes, but for which there is demand. The fact that some can be used to buy dollars (convertible), and some cannot, is beside the point.

            Now, you can show me an example of money that had taxes, but when the taxes disappeared the demand did, as a result.

            By the way, store coupons are yet another common form of money that is not “driven” by taxes, and not convertible. The list goes on and on.

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  2. Interest is but a money making tool of the rich. They invented it and will not allow anything to stop it. The Fed 2% target is arbitrary, but by no coincidence one of many sure ways to help keep the rich rich while the rest struggle by comparison.

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    1. Yes, the rich are in charge, and yes the 2% is arbitrary. But I suspect it was set as a safe distance from a negative interest rate, which is thought to have dire consequences. Though there is not much of an economic difference between, for instance, 1% and 1.5% (a .5 difference), there is huge economic difference between .25% and -.25% (also a .5 difference).

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      1. It was set at 2% to make it easier to prevent deflation, which is (often rightly) thought to be very harmful for an economy. Of course, even if the interest rate was stuck at zero, a bit of helicopter money (QE for the People, NOT for the banks, aka Economic Bonus) would end deflation rather quickly by stoking consumer demand and ending the downward deflationary spiral. Something Japan still has yet to realize, apparently.

        But yes, negative interest rates would literally turn the world of finance upside down, and would backfire by creating a perverse incentive to hoard cash under one’s mattress (or in a big, brown bag inside a zoo, like the song says) to avoid the bank’s monthly maintenance fees. Again, something Japan still is learning the hard way, as is the EU and several of its individual members.

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    2. Interest is indeed a money-making tool of the rich, but if used wisely, We the People can turn it into a too for our own advantage against the ultra-rich as well. Sometimes the master’s tools CAN dismantle the master’s house.

      For example, money created by Overt Congressional Financing has no interest linked to it’s creation, unlike money created by the banks, who always have strings attached to everything. So create more of the former to crowd out the latter, or better yet, nationalize the banks (or at least the big ones). Interest will still exist, primarily as a way to control and stabilize the value of the dollar, but we could put a usury cap on loans lent to individuals (like there was before 1978) while putting no such cap on interest on Treasury securities and savings accounts of all kinds. Then high interest rates will really be something to be envied. Power to the people!

      This is similar to the old distinction the Catholic Church once made back in the day between two different types of loans, “mutuum” (loans to individuals) and “societas” (loans to institutions and organizations). Charging interest on the former was considered usury, while the latter it was not. Of course, those rules were eventually tossed aside like so much garbage, and the rest is history…

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  3. There’s a problem with trying to put money into the economy by just cutting taxes – it just enriches the already wealthy, while “trickling down” to the real economy very little if at all.
    Bush II, then Trump, cut taxes in ways that almost all went to the wealthy and to corporations. For the most part, that money found its way into the asset markets – stocks, bonds, and land. Economist William Lazonick says over 90% of corporate profits go to stock buybacks and dividends, leaving less than 10% for R&D and training, new hires, etc. When someone buys a stock, a very tiny percentage goes to the trading desk to eventually “trickle down” if any, because trading fees are lower than ever now.
    We need direct government spending into the economy, or something like a payroll tax cut – since the payroll tax is regressive – to stimulate the real economy.
    Otherwise we just get asset inflation and leave the rest of the economy uninflated, exactly what we see today.

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