Mar

9

As promised, rates drive inflation:

Nils Poertner writes:

With a bit of imagination, one could see that we may get to zero (or even negative short-term rates in the US)

Larry Williams adds:

Zero rates in Japan did not lead to inflation as most econ minds claimed it would.

William Huggins offers:

Richard Koo from Nomura explains why that was - and it has nothing at all to do with the notion that interest rates -cause- inflation.

Larry Williams asks:

Great post thanks.

Inflation is a result of 1) people raising prices and 2) people paying up so what causes that?

William Huggins responds:

as econ understands things (in the MV = PY framework), inflation would be a rise in P, which can result from a shock to any of the other three variables. the most common oversight though is that V is affected by how people behave too - the willingness to extend (or deny) credit has a huge impact on whether or not a transaction (PY) even takes place.

economic historians have long noted the relationship between M and changes in PY which shows up when Mansa Musa dumps a ton (actually several tons) of gold into the Egyptian economy in the 14th century, when the Spanish flood Europe with Inca and Aztec gold (and again when they "discover" Potosi), and during various state-induced hyperinflationary periods in the 20th century (USSR, Germany, Hungary, etc). but as the US from 1873-1893 shows, changes in V (which almost halved during that period) can influence inflation too which was negative for the period, despite increasing M and Y throughout.

overall, the record shows that big increases in the money supply (as in 2020/21) tend to set off inflation with a bit of a lag (digestion time) unless there are equally significant countervailing forces. the big assumption monetarists make (that Koo questions) is that people -will- borrow as rates come down. his argument (for those who didn't watch) is that if you have negative equity, borrowing at any rate is insanity - the whole mechanism of juicing aggregate demand by lowering interest rates relies on the idea that people who can will. as Koo/Japan points out, there is a limit to such linear thinking.


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