The Cost-Push Economy

One of the quirky aspects of MMT is that people like Billy Mitchell always talk of taxes as a way to limit private-sector spending in order to prevent inflation. It could work that way, I admit. But that's not the point. The point is, people react badly to the idea.

People still think inflation is a problem. So Billy makes his argument and people are left thinking: They want to raise taxes MORE??? And people shake their heads, and nobody wants to listen to Billy the Wise.

But that's not why I'm writing today. I'm writing because Billy said something about inflation. Something I think is wrong. Something that tells me Billy still thinks in terms of demand-pull inflation.

Here's what Billy said: "I agree that taking a dollar from a private citizen reduces their capacity of spend that dollar. That is the very important function of taxation – to ensure that the state can manage total spending and keep it in line with what is required for full employment but not push nominal growth beyond the inflation barrier."

He's talking about a way to manage total spending and keep it in line to avoid breaking through the inflation barrier. This is the same sort of thing Milton Friedman used to say, except Friedman wanted the Federal Reserve to control inflation, and Bill Mitchell wants the IRS to control it. Their methods differ, sure. But their objective -- removing money from circulation -- is the same.

Stop thinking about taxes. This post ain't about taxes. I don't want to talk about how we control the quantity of money. The differences between Fed policy and Bill's MMT approach are not relevant to this post. I want to talk about the point of similarity.

I want to talk about the idea that it is the quantity of money that causes inflation. Of course it is, you know. I don't argue the point. However...

Milton Friedman asked a question: Why the excessive monetary growth?

The answer Friedman provides, which I find totally inadequate, includes three points:
1. the rapid growth of government spending,
2. full-employment policy, and
3. mistakes by the Federal Reserve.

My answer is different. I say conditions changed, and left monetary policy between a rock and a hard place. In the 1950s, when Milton Friedman was honing his ideas to perfection, there was too much money in the economy. You know: "Too much money chasing too few goods." It was a consequence of wartime spending and such.

Prices were going up because there was too much money in circulation. Friedman said we should restrict the quantity of money, and he was right. And we did restrict the quantity of money, and it worked. By 1960, inflation was pretty much at an end. Then we had a few good years. "Camelot," it has been called. Whatever.

Anyway, pretty soon inflation started coming back, what with the war in Viet Nam and all. And if you ask economists today, they still say that in the 1960s and '70s the excessive money growth was the cause of that inflation. Maybe. But "too much money in circulation" was not the driving force.

When inflation came back in the 1960s, it was cost-push inflation. By the 1970s it was obvious. We were getting stagflation. Prices were going up even when demand was going down. There was no more "demand-pull" to cause inflation.

It's easy to tell the difference. In demand-pull inflation, prices go up because we have more money than we know what to do with. In cost-push inflation, prices go up because we either increase income, or we go under. In times of demand-pull inflation, people have money to burn. In times of cost-push inflation, people have to stretch every dollar.

Demand-pull inflation is associated with good times; cost-push inflation, with hard times. By the mid-1970s, the "golden age of post-war capitalism" had reached an end. Times have been hard ever since.

The inflation since that time has been driven by rising costs. People have to have more income, just to stay even. So the choices open to policymakers at the Federal Reserve are to accept inflation, or to have recession. There is no middle ground any more. Just the rock and the hard place: Inflation, or decline.

Yes, we have inflation because of the quantity of money. But there are reasons we have an inflationary quantity of money. Reasons that developed after Milton Friedman had formulated his ideas and written his 1963 book with Anna Schwartz. Reasons Friedman and Schwartz never understood.

Anna Schwartz continues to explain inflation in demand-pull terms.


The question that must be asked is: What is the source of the rising costs that drive cost-push inflation? The answer is clear: The factor cost of money is the source.

In the 1980s, at the Federal Reserve they continued to restrict the quantity of money to fight inflation. In Congress, they came up with all sorts of ways to boost economic growth.

The thing is, if you boost growth you boost spending, and it's spending that causes inflation. But that's not the half of it. What we spend, matters. If we spend money, there's no associated interest cost and we don't have to pay the money back. If we spend credit, we have the cost of interest to deal with. And the repayment of principal.

Our economic policies took money out of circulation and encouraged the reliance on credit. "What we spend" became more costly. The factor cost of money increased.

A factor cost is something like wages or profit, or something that competes with wages and profit. The cost of interest is a factor cost that competes with wages and profit.

The cost of interest is an "extra" cost, a largely unnecessary cost in our economy. Yes of course we need to use credit. But we don't need to use credit for everything. But we do. So, we have this extra cost to deal with, the factor cost of money. And it creates cost-push conditions. And cost-push conditions cause inflation. Inflation, or decline.

In the '90s and the Naughts we have the Federal Reserve letting money grow enough to prevent decline, and still thinking it has to fight inflation by restricting the quantity of money. But it isn't even money that's causing inflation. It's credit-use and the cost of this substitute-for-money that are causing inflation. But nobody sees it. Nobody at the Fed says Hey, wait a minute!

At the Fed, they think they have to restrict the quantity of money even more. And of course Congress is happy to do more to encourage spending and the use of credit, to stimulate growth.

And, yeah, they did. But the economy wasn't working very well, so of course Congress had to do even more to boost credit-use. And then one day we had so little money and so much debt that we couldn't afford our debt anymore. Then we had a financial crisis.

And, somehow, the crisis seemed to catch everyone by surprise.


Meanwhile, Billy Mitchell, like Milton Friedman and Anna Schwartz, writes of taking dollars from people, to manage total spending, so that we may prevent inflation.

It's all wrong. It's just all wrong. It isn't even money that causes inflation anymore. It is credit-use that causes inflation. And it is the cost of credit-use that causes cost-push inflation.