August 5, 2023

There is a quasi-official claim that raising interest rates lowers inflation. A few critics say it is not true. The seemingly obvious logic says it is a total fraud. So the logic needs to be more directly described.

The first problem is a back and forth twist in the logic of what inflation is. Most basically, inflation is viewed as an increase in cost of products. But then the frauds need to reconceptualize what inflation is to get to their absurd end point. They make a vague association between money supply and inflation, which is so absurd that anything goes in contriving the consequences.

So the first point is that the state of the money supply is nothing resembling inflation. Money supply needs to increase, as banks around the world store the money due to balance of trade results. So money supply needs to increase with demand independent of inflation.

Banks used to increase the money supply by loaning. They loaned money out which did not exist and then collected it from borrowers, which increased the money supply at approximately the rate at which the economy expanded.

That process hasn't been working very well with the advent of high technology, because there is no collateral to secure the loans. High technology comes out of someone's head with no collateral. So venture capitalists finance high technology instead of banks. That takes a large chunk of the economy out of the hands of the banking system and prevents the money supply from adequately increasing as the economy expands.

So the fix was to increase the money supply though "quantitative easing." That means the Federal Reserve created money out of thin air instead of bank loans doing so. Quantitative easing became particularly necessary in response to globalization of the economy, as dollars got rapidly absorbed in banks around the world and needed to be generated for that process.

Where does inflation enter into that process? There is no relationship to the cost of products in adjusting the money supply. The cost of products in a highly competitive economy is due entirely to the cost of production. Increasing the cost of production is the only cause of inflation on an average which eliminates the quirky exceptions.

That means the obvious truth is that screwing things up creates inflation; and making things work smoothly prevents inflation. And guess what, nothing could screw things up more than increasing interest rates. Increased interest rates cause banks to collapse overnight with no forewarning and businesses to increase prices to hedge against the oncoming disasters. That's how the frauds claim to reduce inflation by increasing interest rates.

The half-baked logic of increasing interest rates is that you have to put people out of work to lower consumer demand as the fix for inflation. Huh? Why not kick the dog instead.

That logic starts with the conservative premise that corporations cannot produce enough products without the government giving them a tax break, so there needs to be a reduction in demand to force businesses to lower their prices. Why not outlaw advertising instead? The purpose of advertising is to increase consumer demand.

Reduction in demand will invariably result in increased prices, because no business operates at a loss. That means dumping helicopter money onto the streets would be more effective at lowering inflation that putting people out of work.

The proof is in the pudding. Trainloads of the pudding were produced by Paul Volcker in raising interest rates during the late 1970s and early 1980s. As he jacked up interest rates, inflation went up to 23%.

Then there is the claim that people need to spend less to lower inflation. Trying to find a logic in such claims is too ridiculous to be relevant. How it influences production cost is the only factor relevant to inflation. How could reduced spending do anything but increase costs, which means increased inflation?

Why would producers lower cost if people buy less? They have to increase prices when encumbrances develop.

One of the absurd bits of logic behind the nonsense is a required premise that producers (both manufacturers and sellers) have a great big slush bucket of money which they can draw from or give away at will. Not under normal circumstances, they don't. They try to achieve a few percent profit. It's percent, not an arbitrary dipping into an endless well of cash. There are exceptions; but they don't shape the economy.

Percent profit means costs determine prices. Anything other than that requires the endless slush bucket that doesn't normally exist.

All of the nonsense would increase costs as inflation, while such nonsense mechanisms are said to lower inflation.

In other words, the nonsense of economists is an attempt to disconnect inflation from cost of production, as if some green Martian lala effect existed. There is never going to be a disconnect between cost and inflation under average conditions.

Of course, there are always fluctuations, where different influences do not act in unison; but that is true of all equilibrium processes. Component effects move toward equilibrium at different rates. That is an automatic process which gains nothing by jacking effects around. And equilibration effects are very small compared to the destruction of economies that results from impositions.

Improving economies requires solving real problems, not throwing wrenches into everything as the fix.