Understanding economics is different from learning other trades. For example, take machining or dentistry. The knowledge in these areas gets acquired and then passed along through generations. But with economics it’s often figured out on the fly. That’s because conditions in this field change. Take inflation.
For the past 50 years central bankers have focused on this issue. Previously, their mandate was to control inflation and encourage employment—both at the same time. But during the reality of the 1970s, bankers were forced into making a choice. Faced with the conundrum of high inflation and not enough jobs, Milton Friedman claimed the two could never be satisfied at once. He said the concern for inflation must always come first and that’s what central bankers did. They shifted focus.
Two levers
Big banks started managing inflation by using two levers: control interest and print money. When things look good keep rates low, but once inflation rears its ugly head, rates go back up. Then when the economy is suffering, push rates down to provide stimulus. That’s how they saw rates. The second lever involved putting money in and out of the system (by printing and destroying).
Together these levers worked well up until the crash of ‘08, which was a big one. Central banks reacted by lowering interest rates and increasing their part in world money supply from $46 to $69 trillion. Yes, they created 23 trillion dollars in just ten years. Traditionalists expected bigtime inflation to follow since more money was now chasing the same number of goods but that didn’t happen. We experienced only regular inflation (because it’s easy to make more goods).
More importantly, over the past few months of 2019 central banks stopped using the interest lever. They figured inflation could now be controlled by simply putting money in and out of the system. This way rates could remain low and government debt would be manageable for the foreseeable future. (What some call, kicking the can down the road.)
Modern Monetary Theory
Then we caught Covid and a whole whack of new debt has been issued. What to do? Well bankers are pondering a new idea. This time, instead of using either of the old levers, they’ll be using taxation. You see the only concern with lots of money in the system is inflation. But what if we could control inflation another way? Here’s the plan.
Imagine if GST floated between 1% and 29. When it’s 29, will you be buying a new car? Probably not. But when it’s at 1%, everything goes on sale. Under this new program government can jack up or down the economy without constraining the money supply. This way we can continue to sustain enormous amounts of debt. It’s like redefining money’s purpose. Sure, money will still facilitate the exchange of services and goods, but in the macro sense it will no longer be part of controlling inflation. And that’s a major change (until the next new theory).