Watching the screen on a gas pump while filling your vehicle’s tank is liable to induce a panic attack. Paying for a used car almost requires taking out a second mortgage. Speaking of mortgages, members of the middle class are being priced out of the housing market as home prices march relentlessly upward. Many price increases are out of control.
How did we get here? A little over a year ago, and in the years before the Covid-19 pandemic, most prices were relatively stable. But more recently, general price inflation is at a 40-year high.
The late economist Milton Friedman helped explain the inflation and stagflation of the 1970s. His explanation helped shape the strong economic recovery of the 1980s, built on the principles of limited government, with sound monetary policy that resulted in a steep decline in what had been rampant, double-digit inflation.
Inflation Is a Monetary Phenomenon
Friedman pointed out that “inflation is always and everywhere a monetary phenomenon.” The seemingly force majeure is actually a manmade problem, caused by the Federal Reserve (Fed) creating too much money. These principles of money and inflation aren’t new.
But those lessons are being disregarded by some in the economics profession. People like Stephanie Kelton have been promoting Modern Monetary Theory (MMT), which is virtually a complete reversal of what Friedman espoused and history demonstrated. This theory contends that the federal government’s current deficit spending isn’t an issue — it can, and should, be solved by the Fed creating money to fund it without concern about inflation as long as the U.S. dollar is the world’s reserve currency.
President Joe Biden has not openly endorsed MMT, but he’s no fan of Friedman either. Instead, he seems content to have many mostly younger congressional Democrats advocate for MMT, which provides convenient and seemingly academic reasoning for financing more federal spending without explicitly raising taxes. It has a similar political appeal that Keynesianism presented almost a century ago, and MMT is just as flawed.
But proponents of MMT do get one thing correct — the Fed can create money to service the debt and avoid a default. But in real terms, meaning adjusting for inflation, this assertion is false. Creating money to service the debt devalues the currency. Investors then receive a lower real return on their holdings of federal debt.
Furthermore, everyone is hurt by inflation, whether they own government bonds or not. Inflation is essentially a tax, as it robs people of their purchasing power at no fault of their own. Everyone who received a 7.5 percent raise over the last year probably thought they would be able to afford more stuff, but they were deceived. Inflation rose just as much — so there was no real raise.
False Claims That Taxes Are the Solution
But MMT proponents claim that the massive budget deficits are what allow people to save money. Were it not for those deficits, they contend, people would have no cash to save. At first glance, the pandemic seemed to support that. People received transfer payments from the government and saved much of them due to uncertainty. But more recently, people’s savings are being depleted as this dependency on government dries up and prices soar.
Now that inflation is running amok, MMT adherents believe tax increases are the primary (if not only) cure. They claim inflation is not caused by the Fed creating too much money, but by people having too much money to spend; taxation will remove that excess liquidity and stop inflation.
However, MMT doesn’t explain why it’s only inflationary when people spend money, but not when the government spends it. Somehow the Fed creating money by purchasing government debt miraculously doesn’t bid up prices for scarce resources. The theory sounds more like a belief than science — something that must be trusted rather than demonstrated.
Specifically, MMT ideology is built on mathematical relationships between economic variables like private and public savings and debt rather than a strong theoretical construct, and breaks down quickly when analyzed with sound economic theory. Moreover, these relationships seem to be used to derive a funding mechanism for their big-government policy goals, such as a federal jobs guarantee, universal healthcare, and other costly initiatives.
How Taxation Might Stop Inflation
But MMT is not entirely wrong on using taxation to stop inflation. If those taxes are used to pay for deficit spending — which really should be done by spending less — rather than the Fed financing it, then higher taxes can lower inflation. But that is far too nuanced of an explanation for MMT, which paints in much broader brushstrokes.
Regardless, MMT cannot dispel the hard truths of monetary policy, which is inflation comes from one place — the Fed. When the Fed creates money faster than the real economy grows, prices will rise; it’s that simple.
To alleviate the uncertainty and distortions across the economy of bad policies in Washington, there should be binding fiscal and monetary rules based on sound economics instead of ideology. This should include changing government spending by less than the growth in personal incomes and only changing the money supply to keep prices stable.
Almost two years after President Biden declared “Milton Friedman isn’t running the show anymore,” the late economist is clearly the one with the last laugh. Perhaps next time, the president will think twice before speaking ill of the dead.
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Vance Ginn, Ph.D.