Thursday, February 18, 2010
MMT is broken
Modern Monetary Theory (MMT) opines that decreases in interest rates portend inflation expectations, which finally leads to inflation. It also assumes that low or zero interest rates stoke inflationary pressures by making the price of credit cheaper. All things being equal, this means a greater demand for credit should follow.
Except there is a problem here, both on the supply and demand sides. Richard Koo has termed this a "balance Sheet Recession" whereby households and corporations are loathe to take on new debt in favor of cleaning up their own balance sheets. Banks are loathe to lend as assumptions for future capital needs are uncertain and access to capital markets are equally unknown.
SO BANKS DO NOT LEND AND THE CREDIT CHANNEL (via monetary policy through rate action) IS BROKEN.
Only FISCAL policy can fix this problem.