MMT/MMters: mistake 3 - the rate of interest

My thoughts started to come together many years ago when I taught here

Usually as we get closer to elections we move closer to silly season for government spending. The latest economic theory that tells government what they want to hear is the one that says for a government that issues its own tokens (currency) the real rate of interest (price of money) is zero. This implies that there is no cost to overspending a budget and borrowing.

MMT obliges by telling this to politicians. Bill Mitchell wrote “the natural rate of interest is zero”. The reasoning behind this statement is clear if you make a number of very questionable assumptions which were Keynesian in origin and have been adapted by MMT. Firstly choose a target for full employment in the economy. Bill Mitchell likes 2% unemployment and this gives almost every economy in the world the intellectual support to kick start spending. Any country that has a higher level of unemployment is then described as having an output gap with insufficient demand to achieve its full employment target. The solution is then to close this output gap by increasing demand in the economy and the easiest way to do this is to increase government spending. This is incorrect as I explained on my blog in “Government spending does not cause the economy to grow….”

However in MMT world it is possible for government to boost aggregate demand by spending more money which does not require further taxation as there is already deficient demand in the economy. This is proven by the fact that the full employment target has not been reached. This additional spending can then be financed by creating more tokens (money) and not incurring any service charge (equivalent to a zero rate of interest). Further to this you can then roll-over the maturing debt and not incur any repayment charge. All sounds too good to be true, and it is, and this is why.

All countries have a natural level of unemployment based upon their institutional factors and a well-run monetary policy will tend to cause countries to settle at this natural level. Badly run policies may cause this level to rise above the natural level, but no amount of demand manipulation can reduce the level of unemployment below the natural level. Therefore as soon as MMT token printing takes place it will add to the rate of inflation. Initially MMT have this position covered as Stephanie Kelton pointed out that all inflations for the last 100 have been of a cost push nature. I dealt with this in a previous MMT mistakes where I explained that all inflations result from excessive monetary demand and if any country has any inflation, no matter how low, then it must have excessive monetary demand.

In reality it is necessary for a growing economy to be supported by growing monetary demand in order to allow more goods and services to be traded at the same average level of prices. This is why it is necessary to have a Central Bank, with an inflation target, to manage monetary growth as close as possible to a target that is 2% above the rate of growth of output. The very last thing an economy needs is a government, driven by an incorrect theory, guessing about how much money to create and spend in the economy.

At present profligate spending by a U. K. government has produced a a National Debt in excess of two trillion pounds and a yearly servicing charge in excess of fifty billion pounds (more than the whole defence budget). This debt is financed by the taxpayer and as debt and debt servicing has increased so government has had to cut back in other areas of spending and this has mistakenly been referred to as austerity. In fact more debt and more spending is being more or less profligate. Overall the government has a significant financial burden that makes it susceptible to any theory that suggests that the National Debt and its servicing can be written off as long as unemployment is above 2%.

There are many economic theories in addition to MMT that suggest the government`s budget is different from the budget of a household and therefore government does not need to abide by the same rules of fiscal prudence. This is correct in only one sense and that is that household finances need to be in good order at the point of death. The fact that government does not die does not mean its finances should not be good order. Suppose you were told you were going to live forever then your loans would never need to be repaid but your financing of those loans would need to be sustainable. It is exactly the same for government but some economic theories profess profligacy is acceptable and if anything goes wrong it reminds government that they know someone who prints money.

The idea that the natural rate of interest is zero is an economic myth. If the government wants to borrow money it must compete with the private sector for the funds that have been created by the incomes of the private sector. The government does not earn an income. Market interest rates are never a nominal zero and MMT need to be reminded that there is a structure to interest rates determined by risk, amount and term (RAT). This structure ranges from low rates at the secured end (mortgages) and high rates at the unsecured end (credit cards and payday loans). At present the Bank of England`s Bank Rate is distorting the secured end and having very little effect at the unsecured end.

Finally let us remove the myth that the natural rate of interest is zero and that there is only one rate of interest when there is a whole structure of rates currently ranging from 0.75% to 2000+%

John Hearn 15/7/19