COVID-19 Is Straining A Lot of Things

At Bloomberg Noah Smith has noticed that COVID-19 (or governments’ response to it) is not just threatening our lives, health, livelihoods, and social fabric. It’s challenging economic doctrine as well:

The big question is when, if ever, this aggressive government action starts to incur negative consequences, such as rapid inflation. Macroeconomists should be investigating this question vigorously. But so far, interest in the question has seemed strangely muted among mainstream academics.

Before the financial crisis of 2008, the dominant academic model of the business cycle held that there was a tradeoff between inflation and unemployment — a new version of what’s known in economics as the Philips Curve. By managing interest rates, mainstream theorists argued, the central bank would navigate serenely between the rocks of inflation and the shoals of unemployment. There was not much room for government debt in that model.

The 2008 recession seemed like it might present a huge challenge for this paradigm, but most macroeconomists met the challenge by simply patching up the old models. They shoehorned in a financial sector, and allowed that when nominal interest rates approached zero, fiscal stimulus along with quantitative easing would have to be brought in.

But that still left the question of what the limits of stimulus and QE would be. Mainstream economists realized that because the government can use monetary policy to lower interest rates and even finance government borrowing directly, there would never be a real risk of sovereign default; if private investors stopped buying Treasuries and rates started to rise, the Fed could pick up the slack. The only real constraint on government action was the possibility of inflation, if the Fed created too much money.

He presents a few graphs to support his point but, for one reason or another, neglects to include what I would think is the one that’s most interesting:

As you can see from the graph above there’s a lot more money than just one year ago. Where’s the inflation? There are several possibilities. Maybe we’re in a “Wile E. Coyote” moment, suspended in mid-air, just waiting for the inevitable crash landing, as depicted in the illustration at the top of this post.

There are rather clearly increases in some commodity prices, e.g. gold, but not in others, e.g. oil, wheat, or in the DJIA. Maybe inflation is there and showing up just in a few places. Note that graph of M3—the enormous increase in the money supply over the last few months isn’t that large when placed in perspective.

Mr. Smith does consider my greater fear—hyperinflation:

Instead of spinning theories that effectively just say that hyperinflation will happen at some unknown point, macroeconomists could look at countries that do experience hyperinflation, or come close but manage to avert it. They should use these historical and international examples to learn lessons about when and where and why this sort of catastrophe happens, and how it can be prevented. But the seminal work on hyperinflation continues to be economist Thomas Sargent’s 1982 paper “The End of Four Big Inflations.” This paper, in addition to being four decades old, draws all its examples from Central European economies in the aftermath of World War I — very different circumstances than the economies of today.

New work on hyperinflation is urgently needed. One key question is whether runaway inflation happens slowly enough that the government can reverse course in time, or whether it’s instantaneous and catastrophic. Another question is whether direct monetary financing of new government borrowing is a trigger for hyperinflation. A third is whether and how capital flight is involved. A fourth is how the type of government spending changes whether markets expect deficits to be temporary or permanent. There are many other important questions besides these.

I can answer the first of those questions. The historic record suggests that the onset of hyperinflation is likely to be sudden. I can’t answer the other three questions.

Something else that the federal government’s response to COVID-19 is challenging is what I have deemed “folk Keynesianism”—the idea that you can spur economic growth just by putting more money into people’s pockets. That hasn’t happened, either. That doesn’t surprise me because you can’t spur greater personal consumption by putting money into people’s products while preventing them from buying by closing down retail stores and doctors’ offices and expect to maintain the health of the economy at the same time.

12 comments… add one
  • bob sykes Link

    Free trade/open borders forces wages and prices toward the global means, and it is deflationary for First World economies. For example, real wages for working class people have been declining for 40 years or more (down 20%?). Middle class compensation has stagnated, and upper class incomes have ballooned. One should also not that the connection between productivity and wages and compensation was broken around 50 years ago, or so. Productivity has soared over that time, but total compensation has stayed flat.

    Of course, the flood of money being poured into the economy (or at least the banking and investment economy) is unprecedented, and hyperinflation is a real possibility. Weimar got Hitler and the Nazis. We would get the Maoists.

  • Free trade/open borders forces wages and prices toward the global means, and it is deflationary for First World economies.

    That’s only partially true. “Free trade” and open borders have kept wages from rising in the U. S. but have had little effect on prices. That’s what I have pointed to when I have written that producers are capturing the preponderance of the economic surplus produced by trade.

  • Drew Link

    Whats the difference between the economy and the banking and investment economy?

  • TastyBits Link

    A loss in confidence in the dollar will result in hyperdeflation. Hyperinflation would require a sudden and significant disruption in available goods and services combined with an increasing supply of dollars.

    With a balance sheet monetary system, all that matters is that both sides of the accounting ledger are balanced. The actual numbers do not matter, and the numbers have no actual value. Mostly, money as a store of wealth does not exist. All that exists is a fiat currency, and it has no intrinsic value.

    Aug. 1971, the US defaulted on the dollar, but the dollar did not collapse. The dollar was balancing too many ledgers to be allowed to fail. For the dollar to collapse, it would take a loss of confidence in the balance sheets, and when that occurs, the dollar will not be the biggest problem.

    (The Roman Empire did not suddenly collapse. It took several centuries. The dollar’s demise may not take as long, but it will not be sudden.)

    All economies are production based. A consumer based economy cannot exist. Production does not require consumption, but consumption does require production.

    Suddenly increasing the money supply will not suddenly increase consumption. People will not begin purchasing additional loaves of bread with additional income, and there will be no sudden inflation. A sudden shortage of loaves of bread could cause sudden inflation, but even then, the regulatory system would limit drastic price inflation.

    With a balance sheet monetary system, the financial industry can product additional goods and services to absorb the additional dollars added to the balance sheet. Hyperinflation events are bubbles, and asset inflation creates accelerating asset inflation. A sudden collapse is caused by a loss of confidence in asset value – hyperdeflation.

    Phil Graham is too stupid to be criminal, and he is too stupid to understand that he is the father of MMT.

    If you are the old @Drew, I hope you and the family are well. If not, you need to get a new name.

    Whats the difference between the economy and the banking and investment economy?

    In a well functioning capitalist system, there is no difference. The monetary system is controlled through hard assets and/or strict regulations. The financial industry creates capital that is used to facilitate the production of goods and services – Adam Smith and his pins.

    In a well functioning financialized system, there is no relationship. The monetary system is controlled through balance sheets and/or accounting regulations. The financial industry creates capital that is used to facilitate the production of financial capital – Stephanie Kelton and her balance sheet.

    If anybody finds MMT distasteful, it can be fixed in 2 to 4 easy steps.

    Burn, Baby Burn

  • steve Link

    Phil Graham is too stupid to be criminal, and he is too stupid to understand that he is the father of MMT.”

    And I thought he was just a crook and a charlatan. Or maybe that was his wife.

    “the banking and investment economy”

    That is where a few people in the investment circle make tons of money and screw over everyone else.



  • TarsTarkas Link

    ‘Whats the difference between the economy and the banking and investment economy?’

    This is my understanding of the difference (better economic thinkers feel free to correct me):

    The banking and investment economy is Wall Street and thus speculation-driven, subject to perception frenzies. Throwing money at it merely accentuates wild swings in prices as that money seeks avenues to gain paper profit or at least revenue. The ‘real’ economy makes and dispenses actual stuff like food, cars, buildings, etc. Unlike paper profits actual stuff, especially non-perishables, don’t go away in economic downturns.

    The three years run-up to COVID-19 produced more stuff than previous speculation-driven bull markets have over the last several decades, and as a result there is more capacity to use as collateral and for production to rebound economically from.

  • jan Link

    Tasty, you’re back!

  • Drew Link

    Ask a simple question………………and only one guy can give a simple answer. And nobody even mentioned the magic words: “the loanable funds market.” Which is comprised of households, governments and businesses. Your know, the “real” economy. Heh.

    But it is good to learn that the “real” economy does nothing but produce unalloyed good, and the products don’t depreciate or become obsolete, and represent the parogons of economic utility, such as pet rocks, Ginzu knives, Facebook chatter or shit happens tee shirts. While the loanable funds market is nothing but just this side of an opium den.

  • parogons of economic utility, such as pet rocks, Ginzu knives,

    Hey! I still have and use my Ginzu. I didn’t buy it—a roommate did and he left it when he moved out.

  • steve Link

    We brought the Ginzu set. Had to try it. Disappointing, but then I love good knives.


  • Grey Shambler Link

    loanable funds market
    So let me see, you are President of a bank or s&l, I’m your golf buddy. Over drinks I come up with a plan to sell Covid masks with tassels–to strippers.. We both laugh but then I submit the plan, with a loan application. You approve the loan for the commission and hell, it might work.
    I get a 10 million dollar business loan, secure a clothing manufacturer in Vietnam to wait for orders. I’m CEO of the LLC @ $1 million a year plus expenses.
    So I spend a year running late night TV ads and visiting strip clubs to drum up orders. I get…..10?16?, can’t remember, orders, (allow eight weeks for delivery), The Vietnamese say they can’t fill an order that size and within a year I file for bankruptcy.
    Next round I buy the drinks. Like that?

  • TastyBits Link

    I am not back, but occasionally, I crawl out of my hole. This is your (plural) world. I am just roasting hotdogs as it burns.

    In any case, I hope that you, your husband, and your son are doing well.

    I was going to mention the 2008 financial collapse being triggered by a loss of confidence in the money market funds, but I was trying to keep it short.

    While the money market funds provide liquidity, they are a tiny part if the financial industry. M3 is the “tip of the iceberg” for money-like financial instruments.

    Currency swaps, interest rate swaps, and credit default swaps are money-like, but they are not traditionally considered money or money-like. They have a role in a well functioning capitalist system, but the financial industry can use them as an end product for the financial system.

    This is what constitutes the “financial economy”. The offshoring of production combined with a balance sheet monetary system is dangerous, and economic theories assuming hard or hard-like money are inoperable and dangerous, as well.

    Like it or not, this is what makes MMT possible. In fact, the biggest retort to MMT is that the money being created is not being used to increase the domestic production capacity, and if anything, it is time to begin shrinking the balance sheet.

    Of course, that would require admitting MMT is real and that the existing system is dangerous, or you all can just piss and moan. I, on the other hand, will roast hotdogs on the inferno you all have created,

    You are an asshole, but you can be a lovable asshole. (As an asshole, I am not sure if that is a compliment or not.)

    @Dave Schuler
    I think that you understand the existing monetary/financial system, but you need to leave the old theories behind. Keynesianism (actual not folk) cannot function in the existing system, even excluding the existing crisis.

    Adam Smith, Lord Keynes, the Austrians, Murray Rutherford, and all non-MMT economists assume a limited money supply, and even with MMT, I doubt Prof. Kelton understands the full implications. For one, determining when the balance sheet has stopped increasing production capacity occurs after the fact, and at that point, it is too late.

    With a balance sheet monetary system, everything is relative, and I am serious about using physics to understand the Modern Monetary System. I have not determined what is the economic speed of light, if one exists.

    Also, my comments are not necessarily aimed at you. Often, I am addressing a larger audience. Anyway, thanks for allowing me to “think out loud”.

    Best wishes to you, your wile, and daughter.

    @Janis Gore
    I hope you are well or as well as can be. I would hug you if I could.

    let the motherf*cker burn

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