Modern monetary theory and inflation – part 1

Modern monetary theory and inflation – Part 1

It regularly comes up in the comments section that Modern Monetary Theory (MMT) lacks a concern for inflation. That somehow we ignore the inflation risk. One of the surprising aspects of the public debate as the current economic crisis unfolded was the repetitive concern that people had about inflation. There concerns echoed at the same time as the real economy in almost every nation collapsed, capacity utilisation rates were going down below 70 per cent and more in most nations and unemployment was sky-rocketing. But still the inflation anxiety was regularly being voiced. These commentators could not believe that rising budget deficits or a significant build-up of bank reserves do not inevitably cause inflation. The fact is that in voicing those concerns just tells me they never really understand how the monetary system operates. Further in suggesting the MMT lacks a concern for inflation those making these statements belie their own lack of research. Full employment and price stability is at the heart of MMT. The body of theory and policy applications that stem from that theory integrate the notion of a nominal anchor as a core element. That is what this blog is about.

One recent commentator said:

** Bill, do you believe governments should be concerned with price stability at all? Do you believe that fiscal sustainability should have anything to do with the level of inflation (in the MMT world in which monetary policy as we know it does not exist).

In all truth, unless you start seriously talking about inflation and how it will be controlled in a “MMT” economy, I think many minds will remain closed to your ideas.

If your response is simply something along the lines of “unemploment [sic] is a greater problem than inflation, we shouldn’t be too worried about it” it is too easy to dismiss your arguments as idealogically [sic] motivated. **


unemployment is always a greater problem than inflation in almost any dimension you want to define it and which are calibrated by metrics that different ideological persuasions agree on – such as lost GDP. There is nothing ideological in the statement that the losses from unemployment dwarf those associated with inflation. Even mainstream textbooks struggle to come up with large estimates of the costs of inflation that they itemise.

Even our favourite sham-book – Mankiw’s Principles of Economics – notes that “inflation does not in itself reduce people’s purchasing power”. He lists “shoe leather costs” (walking to the bank more often); “menu costs” (changing catalogues); “confusion and inconvenience” (but “difficult to judge” how severe); “inflation-induced tax distortions” (mainly impacting on returns to saving); and “arbitrary redistributions of wealth” (if inflation suddenly changes) but the estimated losses arising are nothing like those attributed to persistent unemployment.

There has been no credible study that shows that overall the losses from these “costs” amount to millions of dollars of foregone output every day. There is ample evidence that mass unemployment results in huge permanent losses every day in foregone output and income.

And then if you study the broader literature (health, mental health, sociology, crime, family studies etc) you realise that the macroeconomic losses from unemployment are just the tip of the iceberg. The personal, family and community losses are very large and persist across generations.

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Modern monetary theory and inflation – part 1