Sumner engages the crystal ball

Marcus Nunes brings up an old Sumner post. Old Sumner (from 27 May 2009) says interest rates a few years in the future will be either still near zero, or else they will have gone up to maybe 3.75%. Sumner says:

If I looked into the ball and saw 0.25% fed funds rates in 2011, I would have a sickening feeling—like I’d been punched in the solar plexus. Krugman would be right, we’d be another Japan.

In contrast a 3.75% fed funds rate would put a big smile on my face, as it would indicate nominal GDP growth had bounced back strongly. It would have been a V-shaped recovery.

In my view, promising year after year of near zero rates is like promising year after year of sub-par nominal growth.

I get his point. Policy is promising to keep rates low until economic pressures indicate that higher rates are called for. So if rates are still low in the future, it means higher rates are not needed. Sumner would rather they print even more money than they are printing, enough to push nominal GDP up enough that the economic pressures indicate higher rates are called for. Something like that.

Okay? Now, a question: What are the economic pressures that indicate higher interest rates are called for?

Inflation. That's it, really. People borrowing too much and spending too much, creating upward pressures on prices, leading to inflation.

Oh, and since we know that "inflation is always and everywhere a monetary phenomenon", we know that it was all the money created by all the borrowing that allowed all the spending, that caused the upward pressure on prices. We know that much.

Okay, and our plan is to push interest rates up enough to make people borrow a little less, so that there is less upward pressure on prices. That's the plan. Milton Friedman's plan, and Scott Sumner's plan, and maybe Bill Mitchell's plan.

But look what happened in the time between the zero rates and the 3.75% rates: Spending picked up. Spending picked up because the quantity of money increased, because of the growth of lending. So there is more money in the economy, more credit-money, the money created by lending. And there is more interest cost in the economy because of this increased lending.

By the time policymakers notice inflation is picking up, there is already too much of that money in the economy. Must be, right? I mean, if there is already inflation.

So what the policymakers do then is, they slow the further increase of money by raising interest rates. Or, in Bill Mitchell's case, by raising taxes. Now that's interesting, because Mitchell actually takes some money out of the private economy. (Presumably, the government sits on it instead of spending it, so the money stays out of the economy until inflation abates.)

But the other guys don't take money out of the economy. They leave all the money in the economy, even though it was causing inflation, and they raise interest rates. So they don't fix the problem that was making prices go up. Instead they aggravate the problem by increasing the cost of borrowing.

And if they don't do things exactly right, if they slow the growth of money a bit too much, then they create a recession. A "hard landing". We still have our increased interest costs to deal with, and we still have our increased debt to repay. But now we have fewer jobs and fewer people working.

If we do it Mitchell's way, taxing more instead of raising interest rates, then we have less money. But we still have our increased interest costs to deal with, and we still have our increased debt to repay. Mitchell slows growth, too. And he would have to raise interest rates, or people would just borrow the money they need.

I have a different way to fight inflation. I want to fight inflation by getting people to pay back the money they borrowed, faster. My plan is to accelerate the repayment of debt. If we do it my way, we don't aggravate the problem by raising interest rates. If we do it my way we address the problem directly, by reducing the quantity of money created by lending. So we no longer have our increased debt to repay, because we repaid it as a way to fight inflation.

We also reduce the interest we have to pay, which helps to lower costs. But we don't raise interest rates, so we don't choke off new borrowing and we don't kill off growth.