from Dirk Ehnts, Econoblog101
I have read a book review by Steven Pressman in the Journal of Post Keynesian Economics (JPKE). The book he reviewed is “Rethinking the theory of money, credit, and macroeconomics: A new statement for the twenty-first century” by John Smithin. I am sure the book is just as interesting as the book review, but I would like to focus on a single paragraph that shows a certain disconnect between Post-Keynesian theory and reality.
Please share this article – Go to very top of page, right hand side, for social media buttons.
Pressman writes on p. 8 (my highlighting in bold):
Finally, and most important of all, there is a practical problem. In an inflationary world the Smithin Rule makes sense compared to the Wray (1998, p. 87) Rule, which stipulates that central banks should set the nominal interest rate at zero and park it there. The problem with the Wray Rule, as Rethinking (p. 209) points out, is that with nominal rates set at zero, inflation will accelerate due to conflicts over who loses from rising prices. Monetary policy will not be able to stop this, as lower overnight loans by central banks lead to lower loan rates by banks and more spending. This contradicts Minsky’s (1982, 1986) argument that governments need to stabilize the economy, as opposed to increasing already existing financial fragility. In contrast, the Smithin Rule would require raising nominal rates in times of inflation to keep the real rate at around zero, thereby stemming inflationary pressures.
Living in Germany most of the time in this century, we have been living with a zero interest rates for quite some years now. Inflation has not accelerated even though or because the European Central Bank’s nominal main refinancing operations rate is zero. Why then would anybody chose to discuss the case of zero interest rates “in an inflationary world”? If we would live in an inflationary world, nominal interest rates would not be zero anyway. (I will not be commenting on the issue of real rates, which is a construct that I do not think useful. See this unpublished paper on MMT and DSGE models.)
Also, we have seen zero (or negative) interest rates in the US, Japan, Sweden, Switzerland and elsewhere. Inflationary world? Not ours. Pressman reads Smithin: “lower overnight loans by central banks lead to lower loan rates by banks and more spending”. A leads to B leads to C – this is a sound scientific theory. And we must reject it on empirical grounds:
In the figure, we see that lower [interest rate] overnight loans by central banks lead to lower loan rates by banks. So, A leads to B. But B does not lead to C, as we see: Lower bank rates do not cause more spending and then the inflation rate (black line) moves up. Investment does increase, but not unlike in situations when interest rates were not zero.
So, there is nothing magic about an interest rate of zero. Setting the interest rate at zero therefore does not cause “conflicts of who loses from rising prices” because prices don’t rise. Designing rules “for an inflationary world” seems like an odd thing to do in the 21st century, especially in 2020. We need rules for a deflationary world, a Keynesian world where monetary policy cannot do the job – reach full employment, price stability and sustainable resource management – and fiscal stimulus is needed all the time.
Smithin is right to focus on profits. Nathan Tankus had written about the Kalecki profit equation some weeks ago. It worth revisiting theory with a view to reality. One big question is how the financial side became so independent from the real side of the economy. Looking at profits, and especially capital gains, should lead to more insights about what has happened and why. Once there, we can start thinking about fixing the economy. Pressman concludes that his book review is “meant to inspire John to write a good deal more”. Certainly!
This article appeared on Econoblog101 22 September 2020.
,
include(“/home/aleta/public_html/files/ad_openx.htm”); ?>
