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Modern money and inflation

from Asad Zaman

Milton Friedman was a powerful magician. His words charmed people into believing that night was day, against the evidence of their own eyes. Friedman’s maxim that “inflation is everywhere and always a monetary phenomenon” is widely believed by economists, even though it is abundantly obvious that costs of production, especially energy costs, play a major role in creating inflation.

                                             Pinochet meets Friedman (STF/AFP/Getty Images)

Today, inflation is soaring around the globe. Economists under the spell of Friedman search for, and find, monetary causes. Central Banks around the world pursued vastly expansionary monetary policies to combat the Great Recession which followed the Global Financial Crisis of 2007. To the great surprise of many top-ranked economists, there was no inflationary impact. Emboldened by this experience, Central Banks again poured money into a stuttering economy during the COVID era. Again, inflation did not respond. But now, after the end of all this monetary expansion, high inflation has suddenly hit. Since Friedmanites believe that inflation must have monetary causes, they are forced to think that the fifteen years of monetary expansion since 2008 suddenly caused soaring inflation in 2022.

If we open our eyes to global events, we can find much more obvious sources for the current inflation. The COVID crisis led to the collapse of global supply chains. As global economies recovered, and demand increased to pre-COVID levels, producers found it necessary to turn to alternative, more expensive, suppliers. USA’s intensifying trade wars with China have increased costs of production in both countries. Soaring energy prices in Europe due to the Ukraine War have crippled industry and led to massive price increases USA, Europe, and China are the three largest economies that produce more than 60% of global output. None of these factors have anything to do with the money supply or interest rates. A policy lesson for Pakistan would be to put maximum priority on developing indigenous alternatives for energy production. Not only would this counter imported inflation, but it would also combat climate change which has had disastrous impact in the form of floods.

We will conclude this article by discussing some simple economic theory, which continues to baffle Friedmanites. Friedman’s views are based on a very simple idea of classical economics. Given a fixed amount of goods, if we double the amount of money in the economy, then prices will also double. Keynes observed that this did not hold during the Great Depression, when the production levels were very low relative to what they could be. He noted that pouring money into the economy would lead to increased production. If we double the goods and double the money, then no inflation would result. Friedmanites (monetarists) reject this basic Keynesian idea. They argue that inflow of money does not lead to increased production, so inflation will result from the increased money supply. Empirical experience strongly supports Keynes against Friedman. In contrast to monetarists, Modern Monetary Theory (MMT) builds upon, and sharpens, this Keynesian insight, as we discuss below.

Historical experience showed that expansion of money supply by the Central Bank did not necessarily reach the sectors of the economy where there was high unemployment. Instead, the money might flow into sectors operating at full capacity and cause inflation, contrary to Keynesian views. This phenomenon was termed “stagflation” – unemployment together with inflation. MMT suggests that money should be targeted at unemployment, to prevent this from happening. The key policy recommendation of MMT is a Job Guarantee Program. The most valuable unemployed resource in an economy is the labor. If we spend money on providing a productive job to an unemployed laborer, then the increase in money will automatically be offset by the increase in production. More money combined with more output will not lead to inflation. Job Guarantee programs have been successfully tried in Argentina, India, Sweden, Ethiopia, China, Tunisia, and many other countries. Crafting an effective Job Guarantee program requires ensuring that Central Bank-created money goes to productive labor, not to idle consumers who will increase demand without increasing production. Our youth is the most valuable resource Pakistan has. The most important challenge facing our policymakers is to apply MMT to provide all of them with productive jobs.

Above article was published in DAWN on Nov 12, 2022: https://www.dawn.com/news/1720438

For related articles, see Class-Conflict Theory of Inflation and The Veil of Money

  1. November 28, 2022 at 9:47 pm

    All that is mentioned is accurately explained, and the jobs guarantee is interesting. Even so, solutions or provision for qualitative aspects is unmentioned. Who has the wisdom to direct job creation? Simply look at the trajectory humans are on; plastic molecules in mother’s milk as well as mixed in with every one’s protein molecules begins a very long list. I do believe economics is capable of qualitative analysis.

    A perhaps more difficult question regarding financial promotion of any idea assumes that a creation of money financed project is actually what future people will want. Yes, the future can be taught to want what we want for it. That is a slippery slope to base creation of money on. Real qualitative analysis may only be possible when social decisions are determined in a more open and publicly discussed manner using real economics and real democracy.

    • Edward Ross
      November 28, 2022 at 11:36 pm

      reply to Garrett Connelly I think that your last sentence clearly describes the two ideas that are needed to relate economics to real people and involve them in the conversation. Ted

  2. November 29, 2022 at 1:40 am

    Another way to look at this is to take Friedman’s statement as a definition.

    By that definition, what is happening now is not inflation. It is a real increase in the effort required to produce goods, the effort being reflected in *some* prices (energy, imported components, etc).

    The remedy is to help people (especially the poor) to cope with higher prices. The opposite of what they are doing now, which only helps the financial sector by maintaining money’s purchasing power – at the expense of the poor.

    The same was true in the 1970s. The price of oil quadrupled, slowing economies (“stagnation”), although the US printed money to pay for its war in Vietnam and then exported the resulting inflation (“stagflation”).

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