Mainstream Economic theory and interest rates
There are diverse opinions on monetary policy and its objectives. The mainstream experts see monetary policy as an inflation management tool. They either demand interest rates to remain elevated or further raising them until the inflation gets to 2% target (which i think is really an arbitrary limit). The MMT experts have a view that there’s no rigid relationship between interest rates and inflation as inflation is a complex phenomenon. In fact, Post Keynesians (MMTers are one branch of this tree) see inflation mostly as a conflict phenomenon and recent inflation resulting primarily from supply disruptions due to once in a century pandemic and other factors (war, climate change, sanctions etc).
Non-mainstream economists claim interest rates are kept needlessly elevated even when disinflation has been happening as global economy has normalized after the pandemic. The mainstream experts demand usual demand pull textbook response of central bank in inflation management. Much of all this i have already discussed in previous articles (1, 2, 3). Today, i expand on something more. The motivation on this article came while i was reading essay on Karl Polanyi in the book ‘A Brief History of Economic Thought’ by editor Hassan Bourgrine. Some pages are in pictures below.
Let’s try to look Economic theory at its foundational level. Much of the mainstream economic theory is Shamanistic, performative, symbolic and make-believe system. The theory is significantly prescriptive rather than objectively descriptive. But the mainstream theory derives it’s life and strength when economic agents believe it to be true. The firms, the governments, the household, the markets - all try to behave and act as per the norms of mainstream theory. That’s really the foundation of economic theory. Whether central bank can really manage inflation target with interest rates is not really the point. The point is that the markets, the firms, the economic agents base their decisions on theory that central bank manages inflation with interest rates.
Shamanistic Economics as explained in this old article.
A similar point is vaguely made by other experts in a narrow way. Central bank must be data driven, not data ridden. Central bank must not become shackled to performative aspects of policy (like reaction to economic data which can be interpreted in many ways & sometimes it doesn’t capture the full macro picture) just because it’s the market consensus. The Fed should be objective and sensible instead of being a submissive agent of rudimentary beliefs of the markets.
Quote from article by Claudia Sahm
The existing system gets tranquility from shamanistic economic theory. It’s relieving for central bankers and our economic managers that they maintain some sort of pseudo-control over the system and some ability (although superficial) to nudge it in certain direction. Think on the flip-side, if economic agents just stop subscribing to notions of mainstream theory, the system might turn chaotic. And to restore system to order, some alternate economic theory has to be planted in the minds of economic agents on which they can readjust their roles & behavior.
Some mainstream experts have criticized MMT as progressively prescriptive rather than being objectively descriptive. MMT critics say that it’s not actually explaining how economic system is working, rather MMT is proposing how economic system is supposed to work with MMT as guiding theory. But these experts don’t realize that mainstream theories are riddled with same thing.
And still mainstream theory is not the supreme gospel which omnipotently governs the behavior of economic agents. In fact, projections from mainstream actors may turn out to be wrong (recent example is mainstream consensus on inevitability of recession) yet the mainstream pundits try to subjugate public policy and academic discourse to mainstream theories. May be their hope is that if enough people have faith in mainstream theory and strictly adopt the prescribed roles (marginalists, utilitarians, believers in Philips curve trade-off, disciples of confidence fairy etc), the system will run just as mainstream theories describes - all a make-believe system materializing into actual fruition.
The Central Bank statements (Fedspeak) are shamanistic exercises which supposedly guides “market forces” on the course of economy & what central bank is doing to manage the pathways. So markets should now take their positions accordingly. The central bank is sanctimoniously in charge of managing “expectations” which drive the economy. And mainstream pundits, the temple guardians, say that central bank should respect their sanctimonious ways. One wrong move by Central bankers (like an untimely rate cut) can send the wrong signal to markets which can undo all the hard work.
To be fair, Central bankers (at present) are not ignorant dummies and are aware of complexities and compulsions of our economic system and try their best to navigate through given circumstances. Claudia Sahm who writes extensively on central bank has positive suggestions. Like, central bank should act more democratically, should be more transparent in their operating principles and present its working theories to the public & Congress to understand.
Impossible Trinity
I would end on a slightly different note. Recall how mainstream experts were demanding higher rates to bring down inflation. Then these same experts claimed that higher interest payment are also a form of inflation which hurts consumers sentiment. We are now facing another paradoxical mainstream view. Recently, IMF has criticized high public debts of countries and their fiscal spending binge. At the same time, mainstream experts wants inflation to be tamed with higher interest rates while curbing fiscal spending.
But this is becoming like impossible trinity. Can you have high interest rates, lower fiscal deficits and lower inflation - all at the same time? Higher interest rates means more outlays on debt payments (currently US is paying $1 Trillion on interest payment alone in its budget). This translates into higher deficit and higher growth of public debt. And here MMT’ers claim that $1 Trillion of interest spending (which goes to unproductive rentiers) might create direct & indirect inflationary pressures.