I wrote this yesterday in response to a comment on this blog written by a right-wing opponent of modern monetary theory who claimed that all current inflation was attributable to quantitative easing, which she confused with MMT:
Inflation can be caused for four reasons.
First, if a government tries to spend more within an economy already at productive full employment it will create inflation because the resources required to meet the demand that it is stimulating will not be available. Price increases would, then, be the inevitable consequence. This is an incredibly rare phenomenon because full employment at a living wage, indicating that all labour is used productively, is almost unknown.
Second, inflation can be caused by a shortage of supply. This is particularly relevant when there is a shortage of alternatives to the product in short supply. For example, if all foodstuffs are in short supply then prices for food will, inevitably, rise. If, however, a particular consumer item is in short supply it is more than likely that consumers will substitute alternative expenditure or wait for prices to fall, meaning that the impact of this type of inflation is almost invariably limited.
Third, there are externally imposed shortages of supply. These are most common with regard to energy where producers know that they can, if they wish to for political purposes, create considerable disruption in markets by creating shortages compared to demand. There is almost nothing that a government can do to react to this if they are not themselves a producer of the product in short supply meaning that they have little choice but sit out such situations in the hope that they will correct themselves relatively quickly.
Fourthly, inflation can be imposed by domestic political choice. For example, a government may decide to undertake a politically motivated course of action that has consequences for its exchange rate. Brexit is an example of this. The consequences of the impediments to trade that this created are, inevitably, inflationary.
I added to elaborate these points:
MMT addresses the first of these issues.
The second is about failed supply chains. The answer is market reform.
The third is about foreign policy. MMT is not a theory on foreign policy. But what it does imply is that dependence is dangerous. So, like the second category, the suggestion that MMT makes is that diversification in supply is critical and in this case significantly more renewable energy is required.
The fourth is about government incompetence and the answer is do not elect incompetent governments.
Inflation is not, then, arising for any reason that MMT can address any more than physical policy can address it in the conventional sense, or that monetary policy can address it in any normal sense. We are looking at political phenomena or problems within the real economy that no theory of money can correct, alert might suggest that diversification and competent government are very useful things.
Thoughts, comments and observations would be appreciated. Does this communicate what is necessary is the question I am asking?
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You can explain something to people but you can’t understand it for them.
Nice one.
I think you have captured this well. The only thing I would add is that some goods or services can be subject to a number of the causes of inflation at the same time. Take food. The UK imports 50% of food consumed and therefore is particularly susceptible to external events and domestic policy decisions. From climate change affecting harvests, some governments beginning to stockpile staple items, Brexit and trade policy, labour supply and skills, over complex supply chains, cost of agro chemicals (linked to gas), land use policies etc. None of which will be corrected by pushing up interest rates!
Noted
Back in the day I think it was alleged that greedy Unions seeking ever higher pay for their members caused inflation. Can you say something about this?
I could
I could say it was not a cause but a symptom of inflation and I am discussing causes here
A point that I think is perhaps worth making at this juncture is that in any dynamic closed loop system that contains feedback, cause leads to effect (symptom) but then that symptom becomes the cause of the next upturn, in a repeating behavioural cycle.
It’s also worth recalling that in the 1970s the Unions were not disempowered in the way that they are today. So after an initial, massive step price rise hit the system (via the oil market) and then continued to ramp up, Unions, quite correctly, were able to defend their members’ interests, by demanding higher wages.
And at that time, Unions still had enough clout to achieve their objective. So higher wages led to higher prices which in turn led to higher wages and a positive feedback loop was thereby activated. This spiralling, uncontrollable inflation continued, even after oil prices stabilised, ultimately contributing to the disastrous ascent of Thatcher.
It’s perhaps ironic that we may be spared another such a ‘vicious circle’ of inflation, this time round, because the linkage in that price-wage closed loop was so brutally severed some 40 years ago.
In the day-the 1970s- the Tory newspapers were indeed blaming the unions. One of their heroes contradicted them so they ignored any future comments on this subject. That was Enoch Powell. He believed in things we would now call neo Liberal but he claimed unions were protecting their members.
The major international cause was the quadrupling of the oil price by the Arabs in protest against Western support for Israel.
A major domestic cause, I only realised a few years ago. Ted Heath passed the Competition and Credit Control act which allowed secondary banking and was to assist the ‘dash for growth’. The act was abandoned in 1973.
The early 70s saw a huge inflation in property prices. I bought a house for just under five thousand in 1970 and sold it in 1973 for £10.800. My salary didn’t double.
Nice one Ian.
‘Greedy unions’?
They were definitely stupid unions for not working with the Labour party more closely because in the end we got Margaret Hilda Thatcher.
But not greedy – there was a cost of living crises because of oil and the Unions stepped up to the plate. In addition, by that time the post war economies destroyed by the second world war (Japan, Germany) had well and truly caught up and we were being out-competed. There was also the beginnings of the globalised financialization of industry as well – takeovers, asset stripping etc.
The 1970’s truly gave birth to the world we know today unfortunately.
And you are also right about credit which replaced the real lost wages
House price inflation caused by deliberate government policies?
I make clear that I am addressing consumer price inflation here
Perhaps you should add monopoly power as a cause of inflation (?) – I suppose its a bit of a hybrid of (2) and (3).
I thought your response to “Sarah” hit the nail on the head and was a nice short summary of the issues so I shared it in my networks.
That is worth noting, I agree
Seems spot on, succinct and the the point to me Richard – as you note QE and MMT are not the same, QE being a description of an activity undertaken by a fiat currncy issuer, and MMT being the (T for) theory which both explains and predicts what happens when that action (QE) is implemented imho
I think this is a pretty good explanation.
One area that does need addressing is the “price/wage spiral” or the “embedding of higher inflation expectations”. It seems to me that those wanting firm action on inflation today believe that failure now will only make it worse in the future. “Transitory or embedded”. We should also be asking “what is so bad about a bit of inflation?”
I am still in the “transitory” camp and also of the view that a bit of inflation can be a good thing as it allows relative price adjustment without nominal price falls. Why?
(1) This not the 1970s. Inflation then was driven by a steady increase in oil prices from 3 to 30 dollars at a time when our economy was very energy intensive. It was compounded by the strong bargaining power of labour. Today we use far less energy per unit of GDP and labour has little bargaining power.
(2) We do need an adjustment to house prices. I would rather that came through stable house prices and rising wages (and other prices) than stable wages and a fall in house prices.
(3) Inflation expectations have proved to be a very poor predictor of actual inflation in the future. (There was a paper on this I saw – was it on this blog??)
Finally, we really must ensure that policies we propose (that are possible with an understanding of MMT) are benchmarked NOT against perfection but against existing flawed policy frameworks.
Agreed
the “expectations” thing is a Chicago School, neo-liberal, dinosaur, zombie nostrum. Scarely worth bothering with.
Great post. It all comes across clearly to me.
I have a question about external shortages. While the government might not be able to control the shortage itself, would it be possible for them to limit inflation from it by choosing to subsidise costs to the public in order to keep the prices down? For example, how Eat Out To Help Out actually ended up being deflationary.
Essentially, are price controls a useful tool in this context or are there other problems with them?
Maybe, in the very short term
I think long term investment in resilience more use. Instead we get trade deals with Australia
FWIW – and I’m no expert – but this all seems reasonable/rational to me. For me I’d need to see your suggestions happening and examining the consequences or scenario testing or something like that.
Coming at it though from a more philosophical angle or from first principles:
We live in a world where it is felt by an awful lot of people that Government intervention in markets is to be avoided/not desirable/has nothing but negative consequences.
The thing is that we know a lot more now than what we did in the 1970 s. And market de/unregulation has been allowed to rip through economies for nigh on 60 years and what has it got us exactly?
Intervention in markets is one that must be based on judgement. But who is the judge? If it’s someone whose only concern is the aims and objectives of wealth then that to me is not good enough. If the Government’s aim is less inequality or a market that works well for everyone, then that to me is a better motive.
The rule of interventions should be not to do harm to the more vulnerable in society. It’s as simple as that. And we are a long way from such a rule or ethos being in our Government never mind anyone else’s.
Government’s job is to make the life of its citizens worth living – all of them. Not just an elite. That’s what we’ve supposed to have learnt from WWII.
And the other element is commitment: it’s no good Government doing something and then disengaging. It has to stay in there robustly until its objectives are met. I mean, who rules right? It cannot be halfhearted. It has to be ‘courageous’. Leadership requires courage. The problem is that it is the anti-State supporters who have the courage at the moment and not the those who want a pro-active State!
In terms of looking at the data generated by Government intervention however, we are surely in a better place than we were in the 1970 s to analyse market indicators and network effects to form the basis of further or reduced interventions (knowing when to stop)?
The weak underbelly of interventions is that it is always the situational element and always too easy to blame Government on the action they have taken rather than look more closely about what is happening and how the market is actually causing the problem itself by unreasonable behaviour.
For example I always remember Black Wednesday and the way the finance sector in this country effectively undermined its own Government – which to me was sedition and an offence against national sovereignty. To me the markets on that date should have been forced to close. Sorry, but that’s how I see it.
And then look at a project like BREXIT where malign private forces have been enabled by politics to ruin a perfectly good trade partnership.
And I go back to this point: the currency (which forms the money in circulation) belongs to the State. The State has a say in how it is used. It is not just there to help private banks and individuals enrich themselves with credit and reprehensible products like ‘credit default swaps’.
It is also there to enrich ALL citizens whose wealth collectively makes a up a country’s wealth. There should be enough for everyone.
And if markets (which effectively move money around) don’t help that to happen, the State has every right to intervene and put that right in the name of equality, fairness and democracy.
So to me, we still have to look at first principles and then base interventions on those. Inequality is an open sore at the moment that is causing all sorts of problems and it needs to be addressed.
Calculation of inflation is a bit of a moveable feast anyway. Is that ‘basket of goods’ properly typical? And of relevance to both Rees-Mogg and the man in the street?
Interesting article on some of the history of inflation:
https://www.washingtonpost.com/outlook/2021/05/25/what-scaremongering-about-inflation-gets-wrong/
Only since we started seeing ourselves overwhelmingly as consumers has inflation been seen as such a great enemy – for producers they might actually like a greater opportunity to push through some price rises.
Just as it rather looks as though, most of ours principal food supplier,Tesco, has managed to do…
As a manufacturer I have seen price increases of 100% in timber and steel and close to that in cotton all in the last year or so.
Pre Covid I was able to make a modest living with a turnover of less than £85k – ie no vat registration.
Now the materials bill (for the same number of beds made) is over 60k.
I know that this is mainly down to shortages but I wouldn`t bet too much on prices coming down in the near future (or ever).
As Peter May suggests, the Retail Price Index is a very movable feast, indeed..
Now, I don’t know who is responsible for the ‘basket of goods’ that constitute it, but recent additions have been smart phones and laptops, which, with the exception of really ‘high end’ products, have been coming down in price in real terms, and also actually..
So, the question is, who cooks the books? I haven’t bought a new laptop or smart phone in years, and I wonder how many people have..
In the case of both, most people have seen through the marketing, no matter how seductive, and realised that these products have not improved in any greatly noticable way in about four years.
I have bought a laptop and phone in the last year
But my work depends on them and I hadn’t for some time before then
There are issues with calculating inflation. My inflation is different from your inflation because we buy different stuff… but the ONS does look in aggregate what is bought and I don’t doubt their integrity on this issue.
The real issues are
(1) RPI or CPI. This is an issue of how to treat housing costs along with some Arithmetic/Geometric mean issues. CPI is statistically a better measure
(2) Richard will buy a laptop later this year. He won’t be able to find an exact replacement but he buys will probably cost the same as the last one but be much higher spec. On the surface one might think “laptop inflation is zero” but really it is negative because if a direct replacement were available it would be cheaper.
Finally, an anecdote. I was lecturing to a class of 20/25 year old bankers and trying to get them to pitch a trade idea to me; silence. So I pitched my idea “short Apple stock”; it had just breached the USD 1 trillion market capitalisation mark and my reason was “nothing on this earth is worth USD 1 trillion” and that to justify the price each household in the developed world would have to be spending $3,000 a year on Apple products which was “clearly nonsense”. At which point a young woman spoke up and said that her family spent way more than that…… and others agreed. I was shocked at how much this class were spending on Apple products. It made me feel old and out of touch and reminded me to never assume that everyone else was like me. For the record, Apple is now capitalised at USD 3 trillion!!
Still shocking….
But I have five Apple machines to keep this show functioning
I caught up with the comments yesterday about the rampant inflation caused by too much money. It seems to me that not only do people think about MMT in simplistic terms but also money in general.
Your contributor made at least two points. One that excess money supply always causes inflation. Clearly it does not. Only if you assume a closed system where the supply of goods is fixed and so any increase in money must be absorbed by trade in that fixed supply will this be the case. The world is much more complex than this with demand and supply changing constantly from external sources. In fact if more goods and services are to be demanded and supplied then it is a requisite that more money will be needed to facilitate trade.
The other point was that current inflation was ripping through peoples savings. The obvious issue here is that savings have increased dramatically because of the stimulus and if that is accepted then why should people get to keep the extra savings or for them to be cost free? They haven’t done anything to warrant the increase in wealth they have been given. The downside is that the savings have been unfairly distributed but the rich always moan if they don’t get a free pass.
The relationship between exchange rates, finance/capital movements and trade is vastly more complex than is accepted.
Richard, Thank you, particularly for making clear that you can’t solve an imported fuel crisis by printing money. No more in 2022 than you could in the 1970’s. (Though it is critical that as far as possible intervention does not encourage fuel imports).
I would like to suggest two deflationary processes to add to your list:
1) We know that banks are allowed to “print money” and use it to make loans. But when a loan fails, the deficit is made good with Government-printed money. Not all the money the bank loses will be destroyed, but I think far more goes up in smoke than we realise.
2) A lot of bank lending is against assets, houses etc. This money is locked away, and not available to the economy. Paradoxically, increased house prices will be considered inflationary, but if they represent money taken out of circulation, they will be deflationary. I confess to schadenfreude when I read about the $140 billion locked in bitcoin where the owner has forgotten the password, but that is $140 billion that no longer contributes to the economy.
I am sorry – but the ideas in here are largely wrong
Richard,
I have spent a few days pondering why you think my ideas are largely wrong, but still don’t see it.
After the 2008 bank crash, I spent years trying to work out what had happened to the money that the banks had lost. I could see two possibilities, neither with an easy explanation.
Either
(a) The money the Banks had lent was still somewhere in the system. but if so, where was it?
(b) The money no longer existed, but if so, how had it been destroyed?
Eventually, I concluded that the money was gone, by a mechanism combining asset inflation with loans going bad. Maybe far-fetched, but so is the idea that the money the banks lost in 2008 is still there, just nobody has been able to find it.
A useful place to start is the $140 billion locked into bitcoin, where the owner has forgotten the key.
In theory, the $140 billion represents IOUs that the US Government is committed to honour. In practice, the $140 billion is locked away and can’t play a role in the US economy. Whether the nominal sum is $1 or $1 trillion is irrelevant, it can’t be used.
The absent-minded speculators may have bought their bitcoins more cheaply, and removed a lot less than $140 billion from the economy. However, it will still have been a substantial sum.
I think the idea that money can be locked away is fairly solid, and likely to be significant. More arguable is the idea that locking away can lead to a major process of money destruction, distinct from orderly cancellation.
Suppose that the bitcoin owners miraculously remember their passwords. A lot of them will head for the exit and the price of bitcoin will plummet. A large amount of money, believed to be held in bitcoin, will no longer exist.
An obvious response would be that when a bitcoin was sold at an inflated price, the seller would have put the proceeds back into the wider economy. But would they? I suspect they would be more likely to put the money into another inflatable asset.
I call the money tied up in Bitcoin, Schrodinger money because it may or may not exist, and it may only have value if people do not try to access it. If they try, it may disappear.
I suggest that when the Government tries to calculate how much money is in the economy, Schrodinger money is worth far less than its nominal value. When the Government agonises about “printing too much money”, it should only consider the realisable component of Schrodinger money. The rest has gone.
Remember also
– House prices have increased 3-fold in real terms during my lifetime. Where has that money come from?
– The current level of the stock market
– The pension fund assets that would become redundant if pension payments were offset against pension contributions.
The promise expired
In double-entry terms it was written off as a bad debt
And that is it
You are looking for something that does not exist
You are wasting your time
The double entry is all there is
The asset became a cost
And then it was gone
And the analogy with Bitcoin is wholly spurious – because that is not a currency for a start
In fairness, I have always considered Bitcoin the ultimate Greater Fool investment. At the end of the day some poor sucker will be left holding a string of 0s and 1s, having paid an insane amount of money for them.
But (a) If you study money creation, you also have to consider money destruction.
(b) I may well have got it wrong, but I suggest that with money destruction there is a lot more going on, that is important and not well thought through.
Wrong again
The debt exprires
It really is that simple
Good to see Couscous popped into the basket for ‘21 and 9ct gold chains dropped. I was a big spender on the latter but never touched the former.
It would be interesting to see some research on how much of this basket aligns with consumers and which consumers. Eg it’s well known that pensioners’ inflation is different from most.
Maybe give more emphasis to the difference between the short term ‘blip’ inflation (eg the pandemic?, and or post 2008/09 crash) and a longer term multi year inflation involving feedback between the different causes reinforcing themselves.
The current debate as to how or if the present 5% will subside this year back to the target 2% or below and /or continue into next year and beyond is a good starting point.
Torsten Bell points to the weakness of labour’s ability to bid up wages compared to the 70’s , so that is one way there is less feedback – although at the expense of workers getting even more squeezed – as they have been for 30 years.
We now have the monopolisation and financialisation of crucial markets, which can keep prices higher than ‘they should be’.
There should be an interesting paper here – unless someone has already produced it.
I had missed Andrew’s post last night before putting up my own but it seems we are making a similar point in that the positive feedback loop that existed in the 70s has probably been severed, so we might see an inflation spike but not a spiral.
I see inflation in a much more simplistic light.
To the general public, inflation equals an increase in the cost of Stuff. That means the People Selling Stuff have decided to increase the cost.
The price increases will be because of supply (the People Selling Stuff have had to pay more for the stuff they are selling and are passing that cost along), or because there is more money sloshing around in the economy for whatever reason and the People Selling Stuff want more of it for themselves.
The first of those situations is a difficult one to tackle. The public need to accept that if something is scarce then it has more value. Fair enough. The second situation is, to my mind, just profiteering by People Selling Stuff. Another way of saying that is “markets”.
And they say markets are perfect and self regulating… I despair, I really do.
Interesting comment I came across last year by Charles Goodhart (LSE and former MPC member).
“The world at the moment is in a really rather extraordinary state. We have no general theory of inflation. The Friedman Monetary Theory that inflation is always a result of too much money chasing too few goods …..has become so discredited that Central Banks now do not even mention monetary aggregates at all, and seem embarrassed to do so. ”
ECB forum on Central Banking April 2021 , at 16.00m in this video
https://www.youtube.com/watch?v=w6KQi2tnmIM&t=1005s
I agree with him
But there is no general theory to be had is the answer
The unchecked free market causes inflation, wages have always chased prices, not the other way round.
In a global market, we have the stupid situation where Britain sells potatoes to Germany and Germany sell potatoes back to us, waving to each other as they pass in boats across the channel. WE could call it choice, but I think its all down to increasing the value of goods. Again how the market system works in this country, Potatoes grown in Perth Scotland go down to Covent Garden in London and then end back up in shops in Perth.
Our distribution system is all about inflating prices, but we mustn’t let the cat out of the bag, because people might find out.
I think there are a couple of points that would be worth expanding on which would make this post a much more complete answer to the original comment by Sarah that you replied to, namely:
a) Would we still see Type 2, 3 or 4 Inflation even if there was no additional QE, or money created by other means? In other words, is the fact that we have engaged in further QE in response to the COVID pandemic and the inflation we are currently seeing a case of “correlation does not imply causation”?
b) What effect will creating new money when responding to Type 2, 3 or 4 inflation have?
To expand on b), while as you mentioned MMT doesn’t have anything to say to directly address the causes for Type 2, 3 and 4 inflation, some of the solutions you proposed, particularly to address Type 2 and 3 inflation will require further government investment to work, in which case the “and how are we going to pay for this investment?” will inevitably be asked, to which MMT will be brought up as an answer by its proponents, to which right-wing commenters (particularly those who believe in the simplistic view that MMT is just “print more money”) will eventually reply with a post along the lines of “you want to fight inflation by creating MORE money, are you mad?”.
As such, expanding on what creating new money would do in respond to Type 2, 3 and 4 inflation would (hopefully) help respond to that question, or at the very least you will have a very convenient post to link back to should other trolls engage in that line of commenting, as seen in previous posts.
My understanding on this would be to say that, if resolving Type 2 and 3 inflation (not sure about 4) requires investment to support the proposed solutions, AND we have available labour and resources to achieve this, but don’t have the money, then money created exclusively to address the cause of this issue would not be inflationary, and may even be somewhat deflationary (e.g. new jobs will create new economic activity and therefore additional revenue without having to change taxes), whereas if money was created for any other purpose, at most it will not have any (further) effect on the inflation observed, and at worst it would exacerbate the problem.
Having said that, I realize this is a very simplistic view, and that a lot more caveats may need to be added to make this view more accurate. I can think of one so far (e.g. if there is already a lot of money around due to previous rounds of QE that was not properly targeted, that money will need to be taxed away from the rich or “parked” into Green New Deal savings accounts to prevent asset inflation and/or that extra money from being used to lobby the government against the proposed solutions), anyone else have any further suggestions?
Sorry for the dealy in replying – I tried to take yesterday off thinking about issues like this
I see no relation between 2,3 and 4 inflation and QE because there is none – they relate to different penhoemna
Creating new money that creates new employment is never an issue – it pays for itself – the point you make
But I get your point that I will need to address this
So, thanks!
Richard,
It seems that your right-wing commenter has created a red herring by inventing “four reasons for inflation” when there are just two well-recognised types of inflation:
Cost Push and Demand Pull
Everything else fits within those categories. I would refer her to a simple Wiki type of link for them and let her reconcile her own rant with that well-established principle.
Then provide another relatively neutral, easy-read link that explains the difference between QE and MMT (if you have one on hand). At that point she should figure the rest out for herself.
You are not obliged to assist the unqualified in their ham-fisted attempts at re-framing an issue, nor are you obliged to answer commenters on THEIR terms when they are clearly just making stuff up.
For amusement it might also be worth pointing out that QE has been around for 12 years and the current inflation hasn’t.
Meanwhile in geek-world, Just In Time inventory management is (rightly I believe) being cast as one of the main villains of our current, supply chain related, cost-push inflation. I imagine that you’d have already covered that.
If you haven’t you might consider it.
https://www.nytimes.com/2021/06/01/business/coronavirus-global-shortages.html
https://www.fb.org/market-intel/inflation-and-the-supply-chain
Clarification: I imagine that you would have covered Just In Time management – in a separate post – is what I meant by that (sorry).
Cheers.