Spiral Staircase
Read any article on the economy discussing rising prices and it will say that central banks will have to raise interest rates to stop it. It may be in the last sentence, perhaps even the last paragraph, but it will always be the last word on the subject.

There will never be any discussion of how it is expected to stop inflation, or even if it has ever stopped inflation before. It is an article of faith. A statement that shows which belief system you belong to.

So let’s commit blasphemy and question the faith.

The Myth

The standard line is this from the Bank of England

when we raise Bank Rate, banks will usually increase how much they charge on loans and the interest they offer on savings. This tends to discourage businesses from taking out loans to finance investment, and to encourage people to save rather than spend.

Wrong as a Matter of Accounting

Like all propaganda The Myth sounds very reasonable at first glance. However even a cursory institutional analysis reveals a glaring problem. MMT shows us that The Myth is not compatible with how banks work. Loans create deposits. So if there are fewer loans then there will be fewer deposits. For you to save financially, there has to be a corresponding outstanding loan somewhere.

That’s not a matter of opinion. That’s a matter of accounting fact. Even the Bank of England Agrees.

Overall if loans go down, financial savings must go down by exactly the same amount.

If you want the stock of bank loans to come down, while the stock of bank deposits goes up, then, unfortunately, reality won’t let you do that.

Wrong as a Matter of Business

Why do prices go up? It’s not quite as difficult a question as it seems. A business with an item to sell asks for more money and somebody pays it because they don’t just want the item, they need it. In fact the only reason prices of needed items remain stable in any situation is because there is excess capacity to supply. Only then will market competition keep a lid on prices.

Therefore if I’m in an inflationary situation, I have pricing power. I use loans to fund my inventory because that is capital efficient. If the bank moves the interest rate to 15% then I just put my prices up to compensate. I do that because I’m rational. I know that I have pricing power, I know my customers have no choice but to pay, and the central bank has just embedded my expectations that no new competitors will be forthcoming - since they have stated that their intention is to suppress business investment.

As MMT shows the cost of credit is incorporated into the cost of all goods and services. The higher the interest rate, the higher the price.

The Myth recommends pouring fuel on the fire. MMT recommends a permanently zero Bank Rate, and making central bankers, along with their expensive entourage, redundant.

Wrong as a Matter of Banking

Interest is income for banks, with which they pay their suppliers - bankers and savers. Therefore the 15% that the firm pays the bank is redistributed to bankers and savers, who then spend the interest back with the firms.

Why? Because the price of goods and services has gone up and people have to spend the income they earn on their savings, and likely draw upon their savings as well to pay the new prices. Savings are more likely to be drawn down than added to in a high inflation/high interest rate environment simply to maintain access to needed goods and services.

The Myth expects people, faced with increasing prices and who haven’t the wage income to meet daily needs, to suddenly start spending less and saving more, solely because interest rates have changed. Yet, when you look at it from the MMT point of view, it is clear, both institutionally and systemically, that it is an extremely unlikely proposition.

Which Leads to an Interest/Price Spiral

Just as rising prices allegedly leads to higher income due to higher wage demands which then confirms and embeds those higher prices, raising interest rates leads to rising prices, which leads to higher income due to interest paid which confirms and embeds those higher prices. It is precisely the same positive feedback process.

If a wage/price spiral leads to doom, then clearly so does an interest/price spiral.

Yesterday’s Ideas with Yesterday’s Solutions

Old generals, who remain in charge long past their sell-by date, always end up fighting the last war rather than the present one. Here we are again in a situation that requires a fresh approach and a fresh view yet all that is rolled out is the demand suppression cavalry to face down a supply-side enemy equipped with machine guns.

It will be a bloodbath, born of incompetence and arrogance topped off with that most destructive of human conditions: unshakeable belief.

The question now, as with austerity before it, is how long will it take, and how many will be made destitute, before people realise that The Myth doesn’t work as advertised.