Over the past several years, Modern Monetary Theory has become de facto U.S. government economic policy. To refresh your memory, MMT posits that the government can spend as much money as it likes without worrying about how to pay for it because essentially, it owes the money to itself, plus it can simply print more money as needed. Since the 2008 global financial crisis, the U.S. has done that mainly through the Federal Reserve, which has seen its balance sheet balloon to $9 trillion as the national debt has swelled to $30 trillion.
The only constraint on government spending, according to MMT, is when inflation gets out of hand, at which time the government should impose tax increases and reestablish equilibrium. There doesn't appear to be any magic number for what constitutes worrisome inflation, but reasonable people surely believe we have already reached that point, which should mean that the time is right to start raising taxes.
Not surprisingly, recent converts to MMT only really like the first part of the theory since it gives the government license to spend freely and not have to worry about the consequences. Now, however, MMT is being put fully to the test; inflation is here.
As we have seen, though, there is absolutely no interest in Washington to raise taxes to fight inflation and pay for out-of-control spending. Instead, we are now beholden to the two people, namely President Biden and Fed chair Jerome Powell, most responsible for creating the inflationary pressures in the first place to stuff the inflationary genie back into the bottle. Can they do it?
It's certainly easy to blame all of the recent price hikes on Vladimir Putin and his senseless invasion of Ukraine, and they have certainly played a major role in the most recent spike in energy and agriculture prices. But Powell and Biden had a good head start on him.
In the short time he's been in office, Biden has championed just about every Progressive policy demand, whether it's embracing green energy (and abandoning fossil fuels), unnecessary stimulus payments, endless rent, mortgage and student loan holidays, or policies that discourage people from working, little of which have been paid for other than through deficit spending. For his part, Powell has largely obliged, and this certainly goes back to the Trump Administration as well, by buying up as many government bonds as he can while maintaining interest rates at or near zero.
It's been a neat trick, certainly, but at some point, even true MMT adherents agree that the piper has to be paid in the form of higher taxes. Unfortunately, that is pretty much a political non-starter, especially now in the middle of an international crisis in an election year.
The alternative, of course, is that profligate fiscal and monetary policies will need to be severely reined in order to stifle inflation. Unfortunately, we can't expect much from those on the fiscal side, meaning Congress and the White House, given that they believe that their only role is to spend money. This leaves it up to Powell and the Fed to once again do all the dirty work, which will involve raising interest rates and ending the Fed's massive buying of Treasury securities.
Next week, the Fed is expected to begin the process by raising its target interest rate by 25 basis points, which presumably will be followed by several more increases, although at his recent Congressional appearance, Powell refrained from looking beyond next week, saying that any future moves would be dictated by how well inflation responds to the Fed's initial hike.
It's hard to believe that one quarter-point increase in the fed funds rate and the ending of new asset purchases, while the Fed balance sheet continues to build, is going to do very much to tame inflation, so it's reasonable to expect that the Fed will need to continue the monetary tightening process for a while, probably well into next year. Even if the Fed were to raise interest rates another 100 or 200 basis points, it's difficult to imagine that it will have much effect on inflation that is now running three or four times that level.
At the end of this whole saga, Powell will deserve some kind of award for repeatedly being asked to keep the economy running strong, absorb massive federal spending, and then turn around and try to stifle inflation, all while trying to keep consumers and investors happy. The first part, borrowing enormous amounts of money at the click of a computer mouse, was relatively easy.
Whether he can successfully pull off the second part of the act remains to be seen. He'll get no help from anyone else.
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INO.com Contributor - Fed & Interest Rates
Disclosure: This article is the opinion of the contributor themselves. The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. This contributor is not receiving compensation (other than from INO.com) for their opinion.