The Innocent Fraud Dogma of the Phillips Curve Versus Reality
The economics of the Federal Reserve is backwards and has been since it's creation. Probably everyone working there knows this. But they still use the rhetoric of controlling inflation to justify interest rate rises and falls. They think that raising interest rates will prevent bubble economies to this very day. The Wall Street Journal Reports:
"Janet Yellen Expects Interest Rate Increase This Year"
Somehow it is important to her to control the economy by raising the interest rates charged banks. Somehow the whole world thinks that the way to prosperity and economic survival is:
"Fed chief says ‘gradual pace of tightening’ expected to follow first rate hike." [Yellen]
But she repeats the old chestnut anyway. It's now dogma:
"Central to the argument she set out to establish is a belief that slack in the economy has diminished to a point where inflation pressures should start to gradually build in the coming years. Ms. Yellen argued those pressures aren’t asserting themselves yet, because a strong dollar and falling oil and import prices are placing temporary downward pressure on consumer prices. As those headwinds diminish, she predicted, inflation will gradually rise." [Yellen]
But raising interest rates doesn't control inflation. Interest is what drives inflation!
"In making its call on interest rates, the Fed is relying on uncertain models that predict short-run trade-offs between unemployment and inflation. As the jobless rate falls, theory holds, upward pressure on wages and inflation could build." [Yellen]
The "Phillips Curve" as it is known is so problematic that even the institutional economists are beginning to admit it.
"But the precise level of unemployment where this pressure emerges is unknown and tends to vary, leaving the Fed in the dark about the right time to move. Some economists doubt such a relationship—known in academic circles as a “Phillips curve” after the late economist A.W. Phillips—even exists." [Yellen]
Phillips Curve Nonsense as Innocent Fraud
And it's worse than that. The effect that austerity has is to drive up unemployment. In the 70's this same dogma led to crazy high interest rates that eventually created a "new phenomena" (in the USA) called Stagflation. That Stagflation led to the critique of Keynesian Economics known as Monetarism. And it was caused by High Interest rates -- not solved by them.
Despite the evidence that austerity doesn't reduce inflation, that interest rates are what drive the business cycle and that the whole profiteering dogmatic model of our economy is harmful to 90% of us, this is the same ideology that drives Central Banks around the world. Somehow the solution for banks engaging in speculation and predatory lending is to raise interest rates so the people they are loaning to can't pay them back. It's all monstrously insane. Yet if anyone points it out they get stones thrown at them. The Emperor is wearing no clothes. This doesn't work to control inflation and it doesn't work to control bubbles either. A Tax on financial transactions, or the unearned interest from speculation and predatory loans might make a difference, but raising Federal interest rates just decreases the spread between what the Banks charge and the near zero interest they are currently getting from borrowing from the Fed. They make money either way -- and typically they just raise their own interest rates even more than the Fed does.
As far back as September 12 2004 James Galbraith was noting:
"The Fed started boosting rates just before the recent spate of bad economic news revealed slower growth, weak job gains, slumping consumer spending, and falling producer prices." [Galbraith]
It turns out he segueing off of observations of his Father John Kenneth Galbraith, who pointed out in "The Economics of Innocent Fraud" that the whole notion that the Fed was controlling inflation with interest rates was an "innocent fraud."
"'our most prestigious form of fraud, our most elegant escape from reality' (p. 43). According to him, 'only in innocence does it [the Fed] control general consumer and business spending' (p. 47)" [Economics of Innocent Fraud]
"Innocent Fraud is a misleading Term and it describes the entire Tory approach to ideology and reason. Galbraith defines it as not something very innocent:
"Most progenitors of ... innocent fraud are not deliberately in its service. They are unaware of how their views are shaped, how they are had. No clear legal question is involved. Response comes not from violation of law but from personal and social belief. There is no serious sense of guilt; more likely there is self approval." [Innocent]
Innocent Fraud is only innocent in the sense that the fraudsters aren't necessarily even cautious of the con they are pulling. Just that the con is incredibly convenient to the cons and some of the conned alike, that embracing the con and it's "version of truth" and perpetrating it provides incredible "pecuniary" benefits. Thus for folks to accept convention, no matter how discredited, predatory or self destructive it is, and to give into social pressure, "approved and conditioned belief" is only natural and nobody is especially at fault for doing so -- except that such Tory Economics is incredibly destructive and the consequences aren't innocent. Moreover, when the consequences finally lead to that "version of truth" being challenged, the folks with a vested interest in holding onto it tend to get violent and stop behaving as if they were innocent of anything. It's happened before and it is happening now. Tory Economics fails to benefit, even the folks it is sold to.
Indeed Data since James wrote his article in 2004 showed that raising interest rates actually caused slower growth, unemployment and slowed spending. And eventually it crashed Greenspan's entire "Innocent Fraud" of an economic ideology. Yet Yellin still clings to it?!
Tory Economics Versus Commonwealth Economics
Irving Fisher was the one who first noted the difference between nominal and effective interest rates. But he's also the first one to point out the fact that the business cycle is mathematically driven by a combination of debt based money and Fractional Reserve lending. Modern "Whig Economics" owes to him, John Kenneth Galbraith as well as Alfred Maynard Keynes. They offer alternatives to the sort of privateering, crush the worker, "austerity" economics that is favored even by "Neo-Keynesians" such as Yellin.
The other piece of Tory economics is war-mongering. For Tories the world is a dangerous place. But for the Wolf-Highwayman Tory mentality that's fine because the average Tory sees his or herself as a "wolf among sheep" and loot as a fine outcome of public policy as long as it's not the "Gubbornment" taking it from themselves. The Tory mentality sees nothing wrong with looting the whole world if they can. (More on that on another post). But the fact is that inflation is always associated with warfare.
"the laws of economics remain in force. And one of them says: War causes inflation." [Galbraith-Salon]
Meyer's Terrible Idea
If Janet Yellin, and the congress, really wanted to reign in inflation she'd be charging taxes on unearned income from interest and banking fees. Because as JK Galbraith pointed out dozens of years ago, raising interest rates drives inflation not stops it. But contrary evidence never stops Tory Economists from escalating! Both the Phillips Curve and NAIRU are nonsense, yet here she is using it to justify raising Fed Interest rates on our weak economy!
"Meyer's terrible idea is known as the Non-Accelerating Inflation Rate of Unemployment (NAIRU): the notion that there exists a threshold unemployment rate below which inflation increases without limit. The NAIRU was invented, mainly by Milton Friedman in 1968, in dissent from the prior doctrine of the Phillips Curve, the idea that full employment would entail only a modest rise in the permanent rate of inflation. Then, in the early 1970s, high inflation combined with unemployment to shatter the Phillips Curve. The NAIRU doctrine taught that even trying to push the unemployment rate down with monetary policy was futile; and, worse, that if unemployment were to fall for a substantial time below the NAIRU threshold, inflation would not only rise but also accelerate. This would lead over time to hyperinflation--to financial and social disaster." [Meyer Critique]
Even Democrats have bought this NAIRU nonsense. But James Galbraith skewered this idea years ago. And he noticed that when the evidence says NAIRU is nonsense, folks like Meyer double down:
"By the late 1990s, circumstances had changed. Unemployment was falling below established estimates of the NAIRU--and eventually to levels rarely observed in peacetime. Yet prices remained strikingly stable. Meyer was on the Federal Reserve Board. What to think? What to do?" [Meyer Critique]
And Meyer just trotted it back out.
"As unemployment fell, he would argue that inflation was just around the corner. Therefore (although in appointing him President Clinton had clearly hoped for better), he found himself generally favoring increases in interest rates--not because inflation was rising, but only because his model told him that it soon had to." [Meyer Critique]
Far from an "innocent fraud" this was verging into real fraud. It is one thing to hold onto a theory because it sounds plausible and others believe it too. It's another to double down on a theory because it is convenient and got one a job at the Fed. There was nothing innocent about what the architects of these so-called "innocent" frauds did and do. Galbraith notes:
" it had the side effect of turning Greenspan into the nation's second foremost cheerleader (after Clinton) for the NASDAQ bubble, and thereby precluded serious consideration of policies that might have slowed the bubble without raising interest rates, and thus helped to prolong the period of full-employment prosperity that came into being at that time. In particular, the Fed has the power to order increases in the margin requirement on broker loans, dampening stock market speculation. But such a step would have contradicted the new paradigm view." [Meyer Critique]
This adherence to convenient and self serving arguments leads to pretzel logic when the ideas don't play out as expected. And that is exactly what happened with the Friedman/Greenspan Cons of the 70s-2008. Eventually they'd collapse on their own -- if they weren't religious dogma. Instead as Greenspan did, instead of revising the faulty concepts, the authors are more likely to spin something even crazier.
Old Is New
Galbraith explains that a better explanation of inflation and interest rates is really "Old Keynesianism:"
"We never accepted either the Phillips Curve or the NAIRU. Instead, we believed that full employment was not inherently inflationary; in fact, we saw the greater inflation risk in stagnation itself. In a slowdown, we believe, monopolistic enterprises raise prices in order to try to recover their fixed costs. While on the other hand, full employment production foments ample competition in product markets, high rates of technical change, and declining costs, as businesses seek ways to save on scarce and expensive labor. In other words, productivity growth accelerates because of full employment itself."
To translate the 4 syllable Jargon to simpler terms: higher interest rates + Monopolistic business practices are what drive inflation as monopoly businesses exercise their monopoly power to raise interest rates at the expense of labor and retirees.
It is the banking monopoly over the creation of Credit Money, Corporate Ownership of Natural Resources, Infrastructure and Land and related undue influence over pricing decisions that drives inflation. High Interest rates just make it all the worse for small business and consumers.
Mosler lists his own 7 Deadly Frauds
Mosler's list is associated with the contention that the Government should monetize our debt; rather than privatize our money, depend on credit money where the banks act as middlemen and loan sharks. The logic of this argument is dependent on some assumptions, but the key assumption is the observation that much of government spending is for necessary goods and services that could just as easily be paid for through notes (paper money) or coin (minted money) as farmed out to private banks and "monied persons" who expect to live on the proceeds of their "loans" of money they currently are allowed to print and lend by the Federal Reserve. The more I look at the logic of the arguments the more I see the point. It is also an outgrowth of ideas that date back to Alexander Hamilton and his and Henry Clay's efforts to create an American System. One thing about Tories, is that if they can't agree on who should be King, which God to force on people, or how to share the loot -- they fight.
Thus his "innocent frauds are:
- The government must raise funds through taxation or borrowing in order to spend. In other words, government spending is limited by its ability to tax or borrow.
- With government deficits, we are leaving our debt burden to our children.
- Government budget deficits take away savings.
- Social Security is broken.
- The trade deficit is an unsustainable imbalance that takes away jobs and output.
- We need savings to provide the funds for investment.
- It’s a bad thing that higher deficits today mean higher taxes tomorrow.
I could add to the list. There are alternatives to Tory economics. But to start with it's enough to know they are FOS (Full of Stuff) and that most of their "Stuff" has been identified since the 30's or longer. And we need not be intimidated by these Tories. No matter what Political party they belong to. Their dogmas need to go bye-bye. More to come (and I'll link this to related articles later)
Links and Further Reading
- Irving Fisher.
- The Two Faces of Money:
- Waskelly Wabbit:
- Wall Street Article
- James Galbraith:
- War Causes inflation: [http://www.salon.com/2004/04/20/war_inflation/]
- The Faulty Economics of Laurence Meyer: http://www.washingtonmonthly.com/features/2004/0407.galbraith.html
- The New Industrial State (The James Madison Library in American Politics)
- Some notes
- Economics of Innocent Fraud
- Seven Deadly Innocent Frauds of Economic Policy
- The New Industrial State Kindle Edition by John Kenneth Galbraith (Author), James K. Galbraith (Foreword)
Further reading on Stagflation and Galbraith
(I've been saying this my entire adult life, but it's nice to have someone to quote)
I noticed that Mosler's review of John Kenneth Galbraiths book "The Economics of Innocent Fraud" has a list of 7 items which pointedly leaves out #8. This was frustrating as I was hoping to avoid checking out Galbraith's book by reading Mosler's review because he's spinning what Galbraith says into different directions. Still Mosler's own writing was worth reading because it offers an alternative to the not-so innocent fraud of neo-liberal and neo-keynesian tropes. Mosler is segueing off of Galbraith and not imitating him. And Post Keynesians are not tackling these innocent frauds directly because if they did, we'd have a coup financed by Wall Street. I'm still reading Galbraith's book, thanks to needing a physical copy. This is a big topic. It took a long time for the cons to con us to the point where their frauds seem "innocent" and it doesn't take much to show why they are frauds, but it takes a lot of effort to find the alternatives and defeat Tory (or Privateering) Economics.