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There Really Is Inflation Trouble Ahead

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Large numbers of people are entirely confident that there’s just no risk of any inflation ahead. That vast quantities of money can just be magicked into existence then spent without it having any effect upon prices. The truth here being a little more complex – and the end result being something that Modern Monetary Theory, as well as older monetary theory, already tells us. But which all too few are willing to pay attention to.

For example, The Observer today:

The Bank of England has many battles ahead. Inflation will not be one of them
Phillip Inman

That’s fairly bold confident morning and it’s also wrong. It’s not just that we think there will be an inflation problem it’s that we hope there will be.

The battle is against rising unemployment, business failures and the deflation these will bring. It’s not against the rising prices that are a figment of Haldane’s usually down-to-earth economic calculations.

The standard theory is the money equation. MV=PQ. Money (here, base money, or M0) times the velocity of circulation (the combination of M and V giving us something close to wide money, or M4) equals prices times quantity, or as that can also be called, GDP. Fairly obviously too – GDP is monetised economic activity, thus GDP is equal to the amount of money, the number of times the money is used, because that’s what monetised economic activity is.

So, we find outselve3s in recessionary times, we note that V has fallen, it’s not just fine it’s a very sensible idea to make more M. And boy have we done so. QE is the creation of new base or narrow money – M0. Before 2008 the UK economy chuntered along on perhaps £70 billion of the stuff. Around and about you understand. Today we’ve added £700 billion through QE and still climbing.

Sure, there has been no inflation as yet – if we ignore asset prices – but we don;t actually think that MV=PQ has gone away. On the basis that it’s a definition therefore it won’t go away. All that has happened so far is that V is still compressed. M4, the wide money supply, has not inflated by anything like the old multiples.

And what happens when it does? That’s our trigger for inflation. We’d hope this would happen too because it would mean that we’ve got the economy back to something like normal.

The Modern Monetary Theory explanation says that as long as there are unused resources then we can and should print to spend. We stop doing so when all resources are being used because any more will just produce inflation.

Further, if we’ve got inflation then we should call back in that newly created money and destroy it. Many say this should be done by higher taxation but there’s no requirement for that. We could just sell back those QE bonds to the market, collect the money and destroy that. Sure, that doesn’t accord with the political dreams of many MMTers but it’s entirely consistent with the theory.

What doesn’t change though is that the two theories end us up in the same place. If we get inflation as a result of having printed all this money then we need to reduce the money supply. We can do this – in either theory – by selling the QE bonds or by increasing taxation.

Selling the QE bonds would be an admission that government does still end up borrowing as a result of printing the cash. And that the QE bonds should be counted as a part of the national debt. Higher taxes means that there’s not actually any MMT difference. If we have a high spending government then we’re going to have a high tax government. Whether that’s to curb inflation or to find spending doesn’t really matter, does it? For we’re still going to have more of the economy flowing through that fount of efficiency, the government bureaucracy.

All of which tells us that the Observer is wrong here. The Bank of England does have to worry about inflation. Even under MMT it has to worry about inflation. The only interesting question is when, not if.

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