[jyl]

Originally Posted by MRM

To ask the question is to answer it. The Fed isn't able to meet its inflation goal because the Fed can't create inflation. Our experience in the 1980s and more recent experience of the financial crisis has taught us that previous orthodoxy about the Fed and inflation is backward. The Fed reacts to the economy, it does not pace the economy. Inflation is caused by the market's lack of faith in the currency, not too many dollars chasing too few goods, as was previously thought. The Weimar Republic didn't experience hyperinflation because their central bank printed infinite money, the central bank printed infinite money because the economy experienced hyperinflation. The hyperinflation was triggered by the market's loss of faith in the political leadership and future of the economy. Overprinting money was a symptom of hyperinflation - a reaction to the demand for more currency - not the cause.

Likewise, in the late 1970s and early 80s, inflation was spinning out of control. Urban legend has it that Paul Volker's tight monetary policy broke inflation's back with higher interest rates. That turns out to be a myth. Inflation was tamed by the market's perception that the Reagan Administration was ending the feckless policies that destabilized the economy and devalued the currency. The increase in interest rates was not a factor. The higher rates followed inflation because rates have to rise to keep real rates more or less constant, but again, that was the Fed responding to the economy, not driving it, even if Volker thought it was the other way around.

The Fed can do certain things. It can manage the money supply, which helps prevent the boom and bust panics that the country saw from the Civil War into the early 1900s. It can act as a lender of last resort to prevent the financial system from hitting a liquidity trap and exploding. But it cannot create full employment or prevent inflation. The market's confidence determines the value of the currency, and investments in capital and labor. The Fed will continue to reflect the underlying economy's strengths and weaknesses, noth the other way around.

Very thoughtful and detailed.

What do you think about MMT?