Saturday, September 22, 2012

The crunch was caused by using interest rates as a regulatory tool.

Or at least that’s part of the explanation, and for the following reasons.

There WASN’T any sort of uncontrolled boom prior to the crunch, at least in the sense that inflation was not badly out of control. However, people WERE shifting the resources at their disposal towards property speculation and away from other areas. House prices rose, while the price of other stuff fell (or rose less quickly than it would otherwise have risen). Net effect: no serious inflation.

A rise in interest rates would have choked off the speculation at least to some extent, but that didn’t happen because central banks use interest rate adjustments to control aggregate demand and inflation, and CBs didn’t think inflation merited an interest rate rise.

In contrast, aggregate demand and inflation could be controlled simply by adjusting the rate at which the government / central bank machine creates new money and spends it into the economy (and does the reverse when appropriate: withdraws money and “unprints it”). As to interest rates, they’d be left to look after themselves – and in particular, given increased demand for loans for property speculation, those rates would tend to rise.

MMT is right again.

Now what do you know? The above policy was advocated by Abba Lerner and (I think) most adherents to Modern Monetary Theory. It’s also advocated by Positive Mloney, Prof Richard Werner, and the New Economics Foundation. .

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