Initial Comments On Zippo Charge Per Unit Of Measurement Policy As Well As Inflation Stability

This article represents my initial comments on the inquiry of the stability implications of locking involvement rates at zero. Martin Watts, an Australian academic, had an interesting presentation at the offset Modern Monetary Theory (MMT) conference (link to videos of presentations). Although MMT fits inside a broad-tent Definition of "post-Keynesian" economics, in that place are nevertheless abrupt debates alongside other post-Keynesians. One topic of fence is the number of permanently locking the policy involvement charge per unit of measurement at zero, which is a policy advocated past times many MMT economists. In my view, this is a fence that is best approached past times using stock-flow consistent (SFC) models.

One published newspaper that discusses this topic was written past times Louis-Philippe Rochon together with Mark Setterfield -- "A Kaleckian model of increase together with distribution alongside conflict-inflation together with Post Keynesian nominal involvement charge per unit of measurement rules."* This article was triggered past times my initial reading of the paper; equally the reader volition discover, I have got potent views on how this topic should live approached. I desire to outline my thinking, earlier attempting to explicate their methodology.

I volition summarise the fence equally follows. What happens to the economic scheme if the regime vows that the policy charge per unit of measurement volition live locked at 0% for all time? With the loss of monetary policy (as conventionally understood), volition it live possible for inflation to live stable?

Although nosotros have got had sense alongside key banks keeping rates at depression levels for long periods of time, everyone (such equally JGB bears) only viewed this equally a temporary nation of affairs. Since nosotros have got express historical sense of such a policy (such equally the days of the Federal Reserve pegging involvement rates during together with simply afterward World War II), nosotros ask to move alongside economical models to guess what the effects of the policy mightiness be.

Two Channels from Interest Rate Policy to the Economy

There are ii ways inwards which the policy involvement charge per unit of measurement tin touching the economy. (Note that somebody sector involvement rates are ready equally a spread over the policy rate; I am ignoring the movements inwards that spread for reasons of simplicity here.)

1. Changing involvement rates volition touching the deportment of economical agents (somehow).
2. Changing the policy involvement charge per unit of measurement has an number on the involvement paid past times the regime (and hence involvement received past times the "non-governmental sector" on governmental liabilities).

When nosotros expect at these ii effects, it is clear that nosotros have got a much ameliorate a priori knowledge of the instant number (under the supposition that the yield bend on governmental liabilities is driven past times the policy rate, which is arguably truthful for the floating currency sovereigns). If nosotros have got an justice of the trajectory of the yield bend equally good equally the governmental borrowing requirements, nosotros tin map out fairly accurately the government's futurity borrowing costs -- which is someone else's involvement income. There are to a greater extent than or less odd possibilities to conk on inwards mind. For example, a deranged key banking corporation could purchase upwardly most of the governmental debt outstanding, together with pay involvement on reserves. In such a case, the intra-governmental flows are different, but the cyberspace involvement received past times the non-government sector is the same (except that to a greater extent than or less of it similar a shot comes from the key banking corporation instead of from Treasury bills).

(Changing involvement rates volition also redistribute income inside the somebody sector; this is to a greater extent than complicated to model, but inwards regulation nosotros tin produce it.)

The offset number -- the number on deportment is evidently to a greater extent than hard to judge. There are many unlike ways inwards which involvement rates tin touching behaviour. Unfortunately, in that place is a vogue to ignore the income effects together with focus entirely upon the behavioural effects inwards economical theory (particularly inwards mainstream economical theory).

The purpose of a properly constructed stock-flow consistent model is to highlight the human relationship betwixt deportment together with residue sheets. Both effects are taken into account.

What does Interest Income Tell Us?

We tin state a really uncomplicated story most the human relationship betwixt involvement rates together with inflation using involvement income.

We firstly annotation that somebody sector entities facial expression upwardly a budget constraint: how much they tin pass is express past times their existing fiscal resources together with incomes, equally good equally what they tin borrow. (In dynamic stochastic full general equilibrium models, it is possible to borrow against the cyberspace worth of your three-legged descendants 4 billion years inwards the future, but that is non a deportment nosotros encounter inwards real-world behaviour.) Roughly speaking, if nominal prices rise, households ask a ascent inwards nominal income inwards fellowship to purchase the same quantity of goods (under the supposition that borrowing capacity volition non ascent without a rising income).

Therefore, inwards fellowship to sustain inflation, the solid sector needs steadily rising nominal incomes. For workers, this is provided past times wage inflation. However, non all households earn wages. In particular, to a greater extent than or less households last off of involvement payments.

As a result, a rising involvement nib past times the regime would presumably assist sustain an inflation. For those who wishing for a to a greater extent than formal argument, Godley together with Lavoie beak over this inwards the textbook Monetary Economics inwards the context of Model PC (which is implemented inwards the sfc_models framework).

Empirical Results

The figure higher upwardly shows the historical human relationship betwixt the policy charge per unit of measurement together with inflation inwards the US of America during the menstruum 1965-1995.** In fellowship to brand my betoken really clear, I have got added helpful arrows together with text to highlight the big vogue moves inwards these variables. (I have got used the US of America information equally it was the easiest for me to chart; nosotros encounter similar trends over that menstruum inwards most of the developed countries. Having stared at multi-national involvement charge per unit of measurement together with inflation charts for years, I cannot intend of obvious exceptions.)

As tin live seen, the information are consistent alongside the story suggested past times income flows: raising the nominal charge per unit of measurement of involvement is associated alongside a ascent inwards the inflation rate.

The previous paragraph in all likelihood caused considerable distress amid a corking many people. Pretty much everyone has been indoctrinated past times economists into believing the contrary is truthful (that is, yous enhance involvement rates to suppress inflation). Believing that raising involvement rates causes higher inflation is plenty to instruct yous fired from most key banks.

What produce nosotros do?

It seems clear that nosotros ask to live careful most such analysis. We ask models that accept into describe concern human relationship residue canvass effects equally good equally behavioural effects of involvement rates, so that nosotros have got an thought of what the trade-offs are.

In particular, if nosotros believe that institutional/psychological factors brand negative inflation rates hard to sustain (a belief that has empirical support), a permanent 0% nominal charge per unit of measurement of involvement has to a greater extent than or less inherently stabilising properties. Governmental liabilities volition tend to have got a negative existent charge per unit of measurement of interest, together with drag downwardly the income of bondholders. This helps suppress nominal income growth, together with presumably inflation. The inquiry so remains: tin the presumed behavioural effects of depression involvement rates overcome this force? Even if nosotros cannot response the inquiry from the standpoint of pure theory, nosotros at to the lowest degree have got a guidepost to gauge observed data.

In other words, nosotros have got to move alongside a relatively consummate stock-flow consistent model to expect at this question.

Concluding Remarks

At the fourth dimension of writing, the sfc_models framework does non direct back upwardly the powerfulness to examine the number of changing involvement charge per unit of measurement rules. However, such an analysis may live 1 of my offset extensions.

Footnotes:

* Louis-Philippe Rochon & Mark Setterfield (2012) A Kaleckian model of increase together with distribution alongside conflict-inflation together with Post Keynesian nominal involvement charge per unit of measurement rules, Journal of Post Keynesian Economics, 34:3, 497-520.

** Pedants could fence whether nosotros should push clit the Fed Funds effective charge per unit of measurement equally "the policy rate" during the menstruum inwards inquiry (1965-1995). I believe that this terminology is operationally correct, fifty-fifty if the key bank's policy framework had cosmetic changes.

(c) Brian Romanchuk 2017