As I frequently make clear, Monetary Sovereignty is a first “kissin'” cousin to Modern Monetary Theory. They agree on virtually everything, with the exception of the prevention and cure for unemployment and the prevention and cure for inflation.

I touch on both of these at: https://rodgermmitchell.wordpress.com/2012/01/01/why-modern-monetary-theorys-employer-of-last-resort-is-a-bad-idea/ and at https://rodgermmitchell.wordpress.com/2012/01/02/a-reminder-about-why-modern-monetary-theory-mmt-is-wrong-about-inflation/

Warren Mosler and I have had several discussions about inflation and its prevention and cure, with him taking the position that money supply is the key, and me taking the position that money value is the key. For a more complete discussion,, You might look at the inflation post listed above and at https://rodgermmitchell.wordpress.com/2011/04/18/how-monetary-sovereignty-differs-from-modern-monetary-theory-simplified/

In summary, Warren believes raising interest rates is inflationary, because it increases costs (true), and I believe the cost increase is relatively small, and raising interest rates is deflationary, because it increases the value of money.

Today, Warren sent me an Email containing a slightly esoteric, 26 page paper titled, Is There a Cost Channel of Monetary Policy Transmission? An Investigation into the Pricing Behavior of 2,000 Firms

Author(s): Eugenio Gaiotti and Alessandro Secchi Reviewed work(s):Source: Journal of Money, Credit and Banking, Vol. 38, No. 8 (Dec., 2006), pp. 2013-2037
Published by: Ohio State University PressStable URL: http://www.jstor.org/

Warren had received the paper from Nathan Tankus, who said: “Attached is a paper showing empirical support for the cost channel view of monetary policy. What’s significant is that it appears in a very main stream journal (Journal of Money, Credit and Banking). Thought you’d like to have a copy of this.
Nathan Tankus”

Warren sent the paper to me, with this comment: “Part of what I’ve been suggesting- rate hikes may cause inflation etc.”

My response:

“What they (Gaiotti and Secchi) said is: ” . . . in the short run an increase in interest rates may cause prices to rise, rather than to Fall. However, empirical evidence in favor of this hypothesis is not abundant and remains controversial. Virtually all of it is based on aggregate-sometimes sectoral-data and, in particular, on the identification of a short-term positive response of aggregate prices to interest rate shocks. It is well known that macro-evidence regarding the effects of monetary shocks is subject to substantial identification and specification problems and, consequently, to considerable uncertainty of interpretation. ”

Lots of “short run” (one day??), “evidence . . . not abundant,” “controversial” and “uncertainty” words in that paragraph.

I understand the notion that higher interest rates add to business costs, though for most businesses, an increase in interest rates would amount to a minuscule addition to overall costs.

However, the most powerful, empirical evidence we have is this: For many years, the Fed successfully has raised interest rates to control inflation. If raising rates actually caused inflation, and the Fed was compounding the inflation problem, surely that effect be obvious by now.

Rodger

Taking the MMT side, unquestionably an interest increase can increase business costs. Even more so when you consider that some businesses sell to other businesses, and if everyone is borrowing, there will be a multiplier effect. Further, increasing interest rates forces the federal government to pay more on its debts, which adds to the money supply. All of this can be inflationary.

On the Monetary Sovereignty side, increasing interest rates increases the value of the dollar vs other currencies and non-money. This makes imports less costly, and because imports continue to be of increasing importance to our economy, their anti-inflationary effect grows. Even for products that are manufactured in the U.S., imports of parts and raw materials are sensitive to the strength of the dollar.

Since all sales really are a form of barter, in which dollars are traded for goods and services, the more valuable the dollar, the fewer will be needed to trade.

As an aside, the Gaiotti and Secchi paper specified “short run,” and one might question whether this is of prime importance, even if it occurs.

Given all of the above hypotheses, I lean toward the empirical evidence that what the Fed has been doing –raising rates to stop inflation — seems to have kept inflation near the Fed’s target. This approach also has the advantage of being fast, effective in tiny increments, and apolitical.

Contrast that with changing the money supply via tax increases and spending decreases (the MMT) approach, which is slow, requires large, uncertain increments, and is highly political, affecting specific groups unfairly.

Rodger Malcolm Mitchell
http://www.rodgermitchell.com

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No nation can tax itself into prosperity, nor grow without money growth. Monetary Sovereignty: Cutting federal deficits to grow the economy is like applying leeches to cure anemia. Two key equations in economics:
Federal Deficits – Net Imports = Net Private Savings
Gross Domestic Product = Federal Spending + Private Investment and Consumption + Net exports

#MONETARY SOVEREIGNTY

Mitchell’s laws: Reduced money growth never stimulates economic growth. To survive long term, a monetarily non-sovereign government must have a positive balance of payments. Austerity = poverty and leads to civil disorder. Those, who do not understand the differences between Monetary Sovereignty and monetary non-sovereignty, do not understand economics.
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In the post Federal Debt/GDP – a useless ratio, I described the reasons why it was an apples/oranges ratio that had no descriptive or predictive value for any economist – though it is quoted often. You can read the post to see the argument.

Recently, I had a painful conversation with a 24 year old lad who, based on his vast experience, repeatedly told me I was wrong about nearly everything in economics, while providing zero data to support any of his beliefs – in other words, typical.

At one point, when he didn’t understand a basic graph I showed him, he informed me it was “obscure” and “crankish” (I have no idea), and that “most people use the federal deficit as a % of GDP,” a reference mostly irrelevant to our discussion.

Nevertheless, it occured to me that some of my earlier comments regarding Federal Debt/GDP may not apply clearly enough to Federal Deficits/GDP.

By law, the total of all federal deficits constitute the federal debt. I say, “by law,” because the federal debt, i.e. the total of outstanding T-securities, is not functionally necessary. The U.S., being Monetarily Sovereign, does not need to “borrow” the dollars it previously created and has the unlimited ability to create.

More specifically, federal “debt” is the total of all Treasury security accounts held at the Federal Reserve Bank. Essentially these are savings accounts held at “our” bank. To repay the so-called “debt,” the FRB merely debits the T-security accounts and credits checking accounts — exactly the same procedure as when you transfer dollars from your bank savings account to your bank checking account.

Banks boast about the size of their savings account deposits, and work hard to gain savings account deposits, but for reasons unknown, those deposits are not called “deposits,” when they are in the FRB. There, they are misnamed “debt,” and that misnaming has everyone all atither. T-securities are no more “debt” than are bank deposits, and place no burden on the FRB.

T-securities are optional relics of pre-Monetary Sovereignty days. But for the law, they need not exist today in any correspondence with deficits, which are nothing more than the difference between spending and tax collections.

Tweak the law and we could have infinite deficits with no debt, or we could have infinite debt with no deficits. Think about that, and if it puzzles you, feel free to comment on this post; I’ll go into further detail.

Anyway, there are vast numbers of people who not only fret about the Debt/GDP ratio, but also wring their hands about the Deficit/GDP ratio. Here is a historical graph of that later ratio:

The gray bars are recessions. What generality comes to mind about the relationship between the blue line and the gray bars? My generality is: When growth in Deficit/GDP falls, we eventually reach a recession, at which time growth in Deficit/GDP rises and we come out of the recession. If Deficit/GDP were negative to the economy, we would not expect such a result.

One could say it’s a result of automatic stabilizers or even coincidence, but I suggest there can only one serious explanation for such a dramatic graph: Reductions in Deficit/GDP lead to recessions and increases in Deficit/GDP cure recessions.

This should be no surprise, when we also look at the red line, which is deficit growth itself. It too demonstrates how deficit growth drops year after year (as debt hawks worry about deficits and force “revenue neutral” projects) until we have a recession, at which time the government spends stimulus money to get us out of the recession. Then, when we recover, we fall back on our bad, old “cut-deficits” ways.

Memo to debt hawks: If deficit growth were harmful to the economy, wouldn’t you expect to see at least a few occasions when several years of deficit growth led to recession? But that simply does not happen. Why? Partly because Gross Domestic Product = Federal Spending + Private Investment and Consumption + Net exports. And, Federal Deficits – Net Imports = Net Private Savings – two fundamental equations in economics.

Federal deficits are an important component of GDP, Private Investment, Private Consumption and Net Savings. Reduce deficits and you reduce them all.

Perhaps this post can close the book, not only on Debt/GDP but also on Deficit/GDP. The next time you see or hear either of these ratios decried, you’ll know whether the writer or speaker understands economics and Monetary Sovereignty, or is just following the popular myth.

Rodger Malcolm Mitchell
http://www.rodgermitchell.com

==========================================================================================================================================
No nation can tax itself into prosperity, nor grow without money growth. Monetary Sovereignty: Cutting federal deficits to grow the economy is like applying leeches to cure anemia. Two key equations in economics:
Federal Deficits – Net Imports = Net Private Savings
Gross Domestic Product = Federal Spending + Private Investment and Consumption + Net exports

#MONETARY SOVEREIGNTY

Mitchell’s laws: Reduced money growth never stimulates economic growth. To survive long term, a monetarily non-sovereign government must have a positive balance of payments. Austerity = poverty and leads to civil disorder. Those, who do not understand the differences between Monetary Sovereignty and monetary non-sovereignty, do not understand economics.
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My understanding of the Tea Party (does anyone really understand the Tea Party?) is that they are xenophobic and hate the government telling them what to do and what not to do. We all have a bit of the xenophobe in us to the degree that we love our country more than any other, and prefer jobs not to be “exported” to other nations. And we don’t like to be told not to do something we want to do, and vice versa.

I believe the Tea Party to be filled with a bunch of phony-religious, hyper-patriotic, gun-toting nuts. Their web site says, “Gun ownership is sacred.” Guns — this is what they consider sacred?? They love guns and embryos. People? Not so much.

But, I empathize with some of their feelings, particularly about not wanting a “Big-Brotherish” government running my life. I enjoy America’s freedoms (what little is left of them, considering the Patriot Act), and I greatly fear the dictatorial Soviet-style, Cuban-style, North Korean-style, Libyan-style, George Bush trend of our government, all in the name of security.

That said, I also like such government programs as Social Security, Medicare, infrastructure defense, education and food & drug & finance & military protection. I really don’t want to do my own research & development, and I’m not much into home schooling and guarding the coast.

I mention this because a false equation often is made between federal deficit spending and government interference in our lives. The two are not the same.

When I posted “Why Modern Monetary Theory’s Employer of Last Resort is a bad idea,” I indicated I didn’t like the creation of a giant, inept bureaucracy to accomplish what the private sector could accomplish much better. My exact words were:

Rather than attacking unemployment directly, by offering government, make-work jobs, I suggest the government stimulate the overall economy (via increased federal deficits), enabling the private sector to offer more jobs. A stimulated private sector will provide more meaningful and economically beneficial jobs than will a government bureaucracy offering jobs to anyone who wants one.

One reader said, ” I’m hearing a hint of Tea Party sympathy in your questions.” Although gun ownership is a stupid, intentional misreading of the Constitution, and making English mandatory is a thinly-veiled disguise for bigotry, I do support the Tea Party notion that all other things being equal, it is better for people to have the freedom to succeed than to have the government succeed for them.

“Liberalism” and “socialism” are spat upon because, in the minds of many (including liberals and socialists), both these words imply government control. When MMT suggests, to reduce unemployment, the federal government be the Employer of Last Resort (ELR), I rebel for many reasons, one of which it is a further government intrusion/control, when none is necessary.

Government deficit spending is not the same as government control. Eliminating FICA does not place an increased weight of government on our backs. Reducing income tax rates does not create a Big Brother environment.

While government payments can lead to control, the payments in themselves are not controlling; it is only the laws that control. So yes, let us have the government build roads, but also support local road building by giving money to the states and local governments to create the roads of their choice. And yes, let’s have rules to protect our health, our ecology, our finances and our security. I don’t want the government to own or control public radio and TV, but I’d like to see the government give money to these stations so they could afford more programming, and not have to run begging sessions every month or so.

There are things the government does best. There are things the government supports best. We must recognize the difference. We must be selective about government ownership of business while maintaining government regulation of business for the welfare of Americans.

Socialism (federal ownership) no. Liberalism (federal supervision) yes. It can be a fine line, and many people try to confuse it for political purposes, but recognizing and maintaining that line will make us strong.

Rodger Malcolm Mitchell
http://www.rodgermitchell.com

==========================================================================================================================================
No nation can tax itself into prosperity, nor grow without money growth. Monetary Sovereignty: Cutting federal deficits to grow the economy is like applying leeches to cure anemia. Two key equations in economics:
Federal Deficits – Net Imports = Net Private Savings
Gross Domestic Product = Federal Spending + Private Investment and Consumption + Net exports

#MONETARY SOVEREIGNTY

Mitchell’s laws: Reduced money growth never stimulates economic growth. To survive long term, a monetarily non-sovereign government must have a positive balance of payments. Austerity = poverty and leads to civil disorder. Those, who do not understand the differences between Monetary Sovereignty and monetary non-sovereignty, do not understand economics.
==========================================================================================================================================

Thanks to all of you who responded to my post titled “Why Modern Monetary Theory’s Employer of Last Resort is a bad idea.” Your responses were informative and thought provoking.

That post touched on one of the two primary differences between Monetary Sovereignty and what popularly (though perhaps erroneously) is known as Modern Monetary Theory (MMT).

Today, Cullen Roche published a very short and very good post about the Employer of Last Resort (ELR) discussion, and its role relative to MMT. While early founders of MMT believed ELR to be central to the basic concept, I suggest it is at best peripheral, and really more of a hypothetical departure.

MMT (and Monetary Sovereignty – MS) have the same center, the unlimited ability of a Monetarily Sovereign government to control its money supply and to pay any bill of any size, an ability monetarily non-sovereign governments do not have. The U.S. acquired this ability in August 15, 1971, when it went completely off any gold standard.

The center of MMT and MS is merely a factual description of the real workings of a monetary system. (Unfortunately, that “center” does not have its own, unique name, a situation that creates misleading arguments.)

From this factual description, you can create hypotheses about problems and solutions involving, for instance, full employment, inflation control, the income gap and economic growth. These problems and solutions are not mutually exclusive. They are so intertwined that each affects all the others creating classic “unanticipated results” scenarios.

It is human nature, when addressing any problem, to look first at the simplest, most direct solution:

Employment too low? Hire people (the ELR solution).
Inflation? Cut the deficit (the debt-hawk solution).
Income gap? Tax the rich (the Democrat solution).
Economic growth? Trade protectionism. (The populist solution)

Climbing straight over the peak of a mountain may be the simplest, most direct route, but not necessarily the best way to get to the other side. That simplest, the most direct solution can actually be counter-productive. In the previous post, I described why, though ELR is the (seemingly) simplest, most direct solution for unemployment (simply hire ’em), it may not be the best solution. This is one area where MS differs from what is called MMT.

That all is discussed in the previous post and this is a prelude to what I really wanted to remind you about, in an attempt to draw a distinction between MMT and MS.

======================

The other area of difference is the prevention and cure of inflation. Perhaps the most fundamental equation in all of economics is: Value (or Price) = Demand/Supply. Increase the Supply of money or decrease the Demand for money, and the Value of money goes down, i.e. you get inflation.

For adherents of MMT, inflation is a matter of money supply. Thus, inflation is to be prevented and cured by regulating the creation and destruction of dollars. MMT suggests that federal taxes be increased when excessive (above a target rate) inflation appears. In fact, according to MMT, that is a fundamental purpose of taxes – providing value to fiat money.

I agree and disagree. There is no question that removing dollars from the U.S. economy would help prevent/cure inflation, by giving greater value to the remaining dollars. Scarcity increases value. But, I have strong concerns about this approach.

While, in theory, tax increases can prevent inflation, in actual practice, tax changes would be inefficient and damaging. They are far too slow (When will they be collected?), far too political (Which taxes?) and not incremental (How much?). Perhaps most importantly, tax increases remove dollars from the economy, thereby leading to recessions.

Although the federal government has managed to control inflation, federal taxes have not been the controlling device. Interest rates have. That is, while MMT hypotheses have focused on supply, the Fed, in the real world, has focused on demand – successfully. Further, there is no historical relationship between high interest and low GDP growth. On the contrary, there is a slight relationship between high interest rates and high GDP growth.

In an April, 2011 post titled

How Monetary Sovereignty differs from Modern Monetary Theory — simplified, I described the difficulties with using taxes to give value to money, or more specifically, to combat inflation.

All of you who’ve not read that post, please do so. You will see that using taxes to prevent/cure inflation runs headlong into serious operational and political difficulties. The devil truly is in the details.

I’ll close with this thought: The “devil-in-the-details” problem seems endemic to economics, where far too many thought leaders have not had much personal experience with reality.

Those who believe changing taxes to fight inflation, do not understand political reality. Similarly, those whose experience finding, evaluating, hiring, training, directing, motivating, moving, rewarding, supervising and firing employees is limited or non-existent, see no operational or political difficulty with an ELR program.

They think of people as homogeneous “buffer stock.” They do not understand reality.

Having personally found, evaluated, hired, trained . . . etc., etc. thousands of employees during my 50+ years as an owner of several businesses, I have seen the details and met the devil. And he is one mean, unforgiving bugger.

Rodger Malcolm Mitchell
http://www.rodgermitchell.com

==========================================================================================================================================
No nation can tax itself into prosperity, nor grow without money growth. Monetary Sovereignty: Cutting federal deficits to grow the economy is like applying leeches to cure anemia. Two key equations in economics:
Federal Deficits – Net Imports = Net Private Savings
Gross Domestic Product = Federal Spending + Private Investment and Consumption + Net exports

#MONETARY SOVEREIGNTY