in more than National overviewDan McLaughlin considers why inflation is particularly annoying to Democrats. His article contains some interesting observations on how biased incentives shape policy decisions. In terms of money and inflation, McLaughlin misunderstands: The four mechanisms he discusses are not really about monetary policy.
McLaughlin begins promisingly, “When there is too much money chasing too few goods and services, the prices of goods and services rise.” I agree that this is the place to start. Both the demand side and the supply side are important. For total demand, the obvious culprit is monetary policy. For the overall view, it is the combination of misguided regulatory policies and unfortunate global events – the face of epidemic bottlenecks, the war in Ukraine – that is making production generally more difficult. In this case, the available data indicates the strength of liquidity, and therefore money, in the driver’s seat.
This is where McLaughlin deviates from the right path. He is ready to focus on monetary factors. But then he offers four ways to “reduce the money supply.” here they are:
- Reducing public spending so that the government injects less money into the economy.
- Rising interest rates, putting pressure on the economy recession.
- tax increase without Expenditure is increasing, so the government is taking more money out of the economy.
- Stimulating a shift from spending to saving, which reduces the amount of money chasing goods and services.
In fact, none of this is about monetary policy! Of the four, “interest rate hikes” come closest, but even that fundamentally misunderstands how monetary policy works.
The first point relates to fiscal policy. Government spending does not inject money into the economy. This is not monetary policy because it does not change the money supply. Instead, fiscal policy diverts the flow of spending. Because government spending is inefficient to expand total demand, its stimulus effects are small.
The second point seems to be related to monetary policy. Legions of economic commentators and financial journalists talk about the “raising” or “lowering” of Fed rates. They are all wrong. The relevant interest rate, the federal fund rate, is set in the market for overnight bank loans. The Federal Reserve may influence this rate through open market operations or adjust the rate it pays on deposits. He – his no Indication Federal funds rate. The federal fund rate is an objective, not an instrument. Do not confuse the speedometer of the car. Treating the federal fund rate as leverage for policy does more harm than good. monetary policy on moneyNo interest rates.
The error in the third point is the same as in the first point. The government does not take money out of the economy when it raises taxes. Uncle Sam spends tax revenue on public consumption, public investment and interest on the national debt. All this purchasing power remains in the economy, diverted from the spending path that the private sector would have taken. Only if the government destroys the tax money it has collected will the money supply shrink. Taxes, of course, have other serious consequences, such as discouraging employment and investing. But it is also not about monetary policy.
The fourth point combines the errors of the first and third points. Savings reduce consumption, but not the money supply or total spending. When we save, we put our money in deposit accounts in banks or brokerage accounts in investment firms. They spend money on goods, services and assets. By saving, we divert resources from consumption to investment. Financial intermediaries help us to do this by associating excess demand for capital (firms) with excess capital providers (households). Savings reduce the money supply only if savers withdraw money from circulation – for example by stuffing it in their mattresses or burying it in their plots. But it is very rare, and its effect on the money supply is minimal.
There’s a way to save parts of McLaughlin’s analysis. If the central bank adjusts the government deficit by buying bonds, expansive fiscal policy will push prices higher. McLaughlin cites the extraordinary increases in spending that followed the first wave of COVID. But in his opinion, government spending is direct. “[put] More money in the system. ” This is a bug. What put the money into the system was that the Fed bought the new bonds that financed this spending. If the Fed had not absorbed the fiscal expansion, the fiscal expansion would not have caused inflation. So it is monetary policy – not fiscal policy – that does all the work.
Despite his mistakes, McLaughlin’s conclusion seems to be correct: Democrats are uniquely vulnerable to public anger over inflation. This is because the Democrats are very much the easy money party – how many MMT defenders were the Republicans? – as well as those who are actively trying to politicize the Federal Reserve. By formally and informally pushing central bank executives to care more about climate change and social justice than monetary policy, Democrats have planted the seeds of the worst inflation in 40 years.
Inflation is a “complex problem,” McLaughlin admits. Economists on both sides of the political spectrum must admit their mistakes over the past two years. But the way we fix things is by accurately diagnosing the supply-side and supply-side problems. As for the question, we are talking about the activity of the central bank. Unfortunately, none of McLaughlin’s four points are on the field.