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Our nations leaders misunderstanding of the nature of deficits, inflation, and money is slowly killing us.  Their understanding of how the system works leads them to set unrealistic policy goals that not only don't solve the real problem, but often will exacerbate the problem.  One example of this is in energy policy.

Here's what is happening, or at least, is going to happen.  The price of oil is going up.  Since so many things depend on oil, it eventually causes the price of everything else to go up.  Our policy leaders identify this as inflation.  To fight this inflation they do two things.  The monetary policy is to raise interest rates.  The fiscal policy reaction will be to reduce budget deficits.  In both cases, the policy will likely reduce inflation in the short term, but at the cost of raising unemployment.  In the long term it will do nothing to reduce the real culprit of the inflation, and may even make the problem worse.

Most of the traditional tools used to control inflation have everything to do with demand-pull inflation.  That is when aggregate demand in the economy heats up and everybody is working and spending.  The central bank can raise interest rates to discourage further spending and investment.  This causes a slow-down in the economy and inflation is held in-check.  Alternatively, the government can spend less or tax more.  This removes money from people's pockets and they in turn demand fewer goods.  This also causes a slow-down in the economy.  Both of these tools can be argued to be a reasonable response to demand-pull inflation.

The problem comes from when there is a cost-push type of inflation.  When the price of a commodity goes up, normally the open market will regulate it by finding alternatives - no government interference needed.  However, there are some commodities that are so important and unique that either there are no alternatives or very poor alternatives.  Oil is the best example of this.  So many products depend on it and such a huge infrastructure is built on it, that there are few cost-effective alternatives.  There are others, but oil is by far the biggest, baddest example.  When the price of oil goes up, the market just absorbs it because the alternatives aren't there to regulate the price.  This causes the price of everything to go up.

The monetarist economists, founded by Milton Friedman, have captured our government and thinking.  They don't recognize a difference between demand-pull and cost-push inflation.  Instead their credo is "inflation is always and everywhere a monetary phenomenon".  So, their solution is the same as in demand-pull:  Higher interest rates and smaller budget deficits.  Both of which, will cause increased unemployment and likely, recession.  This will fight the inflation short-term, but does nothing to solve the root of the problem.

The reasonable response to cost-push inflation would be to pursue alternatives to the commodity.  Whether that's researching new technology or building an infrastructure to support existing alternatives.  That way the market can start regulating the price, naturally.  

Unfortunately, that is not what happens.  In fact the short-term inflation fighting solutions make the long-term solution worse.  As the government starts cutting back spending to fight the inflation, they may CUT spending that could lead to long-term solutions that find new alternatives or build-up infrastructure to support existing alternatives.  Also, raised interest rates may discourage the private sector from investing in alternatives because they'll not want to borrow at such high rates.

Pretty soon, the cost of oil and gas is going to cause a spike in the CPI.  At that point all the conservatives are going to start crowing about how it's caused by the budget deficit.  We need to make sure that we're armed with the facts to fight this nonsense.  It'll be hard, but it's the only way we can ever hope to get the economy going again without having to always worry about being chocked by oil prices.

I'm posting this in the Money and Public Purpose group which is the Modern Monetary Theory group here at daily kos.  I realize this post isn't necessarily about Modern Monetary Theory.  Most of the analysis is based on only the most fundamental aspects of classic Keynesian economics.  However, I figured it was appropriate since MMT is an extension of the work down by "The Master".  So if you're already a follower of the group, thanks for indulging me, and if you're new to it, I hope you'll follow it to learn more about Modern Monetary Theory.

Originally posted to Money and Public Purpose on Wed May 04, 2011 at 02:36 PM PDT.

Also republished by Community Spotlight.

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Comment Preferences

  •  You forget Article LXI section 5 (5+ / 0-)

    of the United States Constitution, in teahaddist fairy land - "I have a goddamn right to drive my SUV or Hummer as much as I please and ain't no whiny liberal Democrat pinko gonna tell me not to."

    "We have always known that heedless self-interest was bad morals, now we know that it is bad economics." Franklin Delano Roosevelt, Jan. 20, 1937

    by Navy Vet Terp on Wed May 04, 2011 at 02:43:28 PM PDT

    •  Many of our Tea Headed citizens will soon (1+ / 0-)
      Recommended by:
      greengemini

      Be declaring their constitutional right to drive a tank - takes care of that constitutional right and the second amendment all at once, but it will only be the "right" that they can defend b/c they don't have money to drive their tank/SUV/Two Cab truck/ more than a mile anyway.

      We are a modern couple, meaning two "almost" full-time jobs, we are having to look at droping one for one that pays less b/c the higher paying one is so much further away that gas now HAS to be factored into TAKE HOME pay, at least as much as state taxes, health care.

      I got so depressed today, I put $30 into our gas tank, it took it from 1/8 to a little, tiny bit over 1/2.

      Something has to change.  We are doing our part.

      "How can the United States be the Greatest Nation in the World and the only Super Power when its citizens hold bake sales to raise money to pay for life saving medical care?"

      by 4CasandChlo on Wed May 04, 2011 at 09:04:39 PM PDT

      [ Parent ]

      •  Gas prices are likely to fall (0+ / 0-)

        They've been fed by a speculative bubble. The Saudis appear to be on their way to lowering prices and yesterday the price of crude dropped from 9%. There should be some relief at the pump by Memorial Day.

  •  Recommended! (6+ / 0-)

    I didn't think I was going to like this Diary as much as I do.

    Although, I'd put ignorance in first place, along with the total rejection of reality outcomes when you run the scenarios.

    Oil is just what it is.

    Inflation is what happens in a nation that can no longer afford its own infrastructure.

  •  Good diary -- but (2+ / 0-)

    the Friedmanites would challenge your assumption that the cost/price rise of oil will outstrip the "free market's" capacity to adjust.  It's possible that it won't.  And if it doesn't, human life on earth will at a minimum be quite unpleasant.

  •  I suppose it came down to a choice (2+ / 0-)
    Recommended by:
    farmerchuck, Eugene Fitzherbert

    between a few million jobs and $4 gasoline.

    The Obama administration chose the former, I guess they'll have to live with that choice for better or worse . . . .

    •  Don't get it! (0+ / 0-)

      Choice between jobs and lower oil prices? Please explain!

      •  The country was hemorraging jobs (0+ / 0-)

        at the rate of 500-900K a month

        the only way to stop that was through massive deficit spending and quantitative easing, which cause inflation and a weakened dollar, respectively (or in some self-reinforcing cycle).

        Of course, both inflation and a weaker dollar increase gas prices . . .  (that's self evident, right?)

        So in essence the choice was made to shore up jobs at the expense of gas prices (of course, other prices are rising, too, but they're not shown in 3 foot high letters every 1/4 of a mile, so people don't seem to be quite as outraged)

        •  Thanks for filling me in (0+ / 0-)

          on what you think. However, there's not the slightest bit of evidence that QE created any jobs, or had any material effects except for some psychological impacts on speculators. What is clear is that QE added no net financial assets to the economy, even if it did add reserves.

          There's plenty of evidence that Government deficit spending saved and created jobs. Unfortunately, not enough, because the Government used the trickle-down theory of job creation, rather than the direct Federal Job Creation theory, and it didn't work out so well because it didn't create enough demand to get the bailed out banks to begin lending again.

          As for inflation, there's no data showing that Government deficit spending caused inflation at all. There's been some commodity inflation over the past six months, of course. But that's due to cost-push commodity inflation as this diary indicates and it has been caused by increasing oil prices which then spreads to other commodities dependent on oil.

          In other areas, we have no inflation at all. For example, in housing we have continued deflation, as we also seem to have in electronics.

          Your remarks above are relying heavily on the quantity theory of money. But Keynes showed in the 1930s that QTOM doesn't apply at less than full employment. Short of that Government deficit spending can't cause demand-pull inflation.

  •  Oil Speculation is Killing Us (2+ / 0-)

    Oil production is at a 7 year high and demand is dropping. Regular market forces aren't driving the price of oil so conserving won't help as much.

    "With those taxes in there, no damn politician can ever scrap my Social Security program."-Franklin D. Roosevelt

    by Aspe4 on Wed May 04, 2011 at 03:15:43 PM PDT

  •  I would like to join/follow the Money & Purpose (3+ / 0-)
    Recommended by:
    psyched, maddogg, Larsstephens

    Group as I think MMT is one of the most intriguing  and important theories of modern macroeconomics, and I am still trying to wrap my head fully around it.

  •  Don't fight the Fed (1+ / 0-)
    Recommended by:
    NoMoreLies

    With the Federal Reserve holding rates at zero we are going to get inflation.  This is because holding money becomes a losing alternative.  At zero short term rates, the real rate of return on money is negative.  

    This is what happened in the early 2000s.  The Fed held rates at 1% and the price of houses shot through the roof.  If money is paying a negative return, we get bubbles.

    Now oil is another story altogether.  

    •  Fed is a Paper Tiger (0+ / 0-)

      I disagree, dnpvd0111.  We do get bubbles,  but they burst.  So in the long run, fighting the Fed works.  In the short run, it's a crap shoot.

      Personally, I find monetary policy to be ineffective. The Fed raised rates repeatedly in the mid-90s, but the bubble continued to expand.  Finally, when the Fed reversed course in 2007 it had zero effect.  The stock market mistakenly attributed great power to the Fed in these episodes, but perhaps the market has learned its lesson.  How much credibility does Bernanke have these days?

      MMT explains why monetary policy is impotent.  Fiscal policy is far more potent...

    •  We won't get (0+ / 0-)

      demand-pull inflation until we have more or less full employment.

  •  Krugman has an item today ... (2+ / 0-)
    Recommended by:
    Larsstephens, greengemini

    on approximately the same topic. His conclusion:

    So: over the next decade or two I do think that resource scarcity will have major effects on the economy. But it’s an issue for the Department of Energy and such to worry about — not the Fed.

    "The smartest man in the room is not always right." -Richard Holbrooke

    by Demi Moaned on Wed May 04, 2011 at 07:12:47 PM PDT

  •  We needed to get off fossil fuels (5+ / 0-)

    ..do an Apollo Project on renewable and clean energy and electrify our means of transportation.  Yesterday.

    Between Friedman's "Chicago Boys" and the boys from "Big Oil" and "King Coal" - I'm afraid the seeds of our own destruction aren't just sown, but sprouted, and growing like crazy.

    An imbalance between rich and poor is the oldest and most fatal ailment of all republics - Plutarch

    by Anthony Page aka SecondComing on Wed May 04, 2011 at 08:25:36 PM PDT

  •  The price of oil (and gas, by association) (5+ / 0-)

    will not go down until the commodities markets are further regulated.  President Obama needs to sign an Executive Order to either remove crude oil from the commodities exchange until prices stabilize or, remove the day-traders and "on margin" buying of oil futures from the equation.

    Until real change in the financial markets happens, the price of oil, and gasoline, will not drop.  The teabaggers like to say this is all a "supply and demand" thing but the facts, as usual, don't support that.  As stated in this diary, supply is at a high level and demand is waning daily.

    STOP OIL COMMODITIES SPECULATION IN THE FINANCIAL MARKETS!

    He who exercises government by means of his virtue may be compared to the north polar star, which keeps its place and all the stars turn towards it. - Confucius

    by TimRivers on Wed May 04, 2011 at 08:32:34 PM PDT

    •  Might become more stable, but won't go down (0+ / 0-)

      then, either.  The short term highs won't be as high, but the lows won't be as low, either.  That's because the underlying price of oil is being driven by the need to extract increasingly difficult to reach deposits using increasingly more expensive technology to meet burgeoning demand.

      All of those emerging economies -- China, India, Malaysia, on and on and on, are adding car buyers.  The Chinese auto market overtook the US market for the first time in 2009.  Indian auto sales are growing at a similar rate.

      Huge increases in demand for a commodity whose supply can't be scaled to match create an inevitable upward trend in pricing.

      LG: You know what? You got spunk. MR: Well, Yes... LG: I hate spunk!

      by dinotrac on Thu May 05, 2011 at 02:17:40 AM PDT

      [ Parent ]

    •  That's key (0+ / 0-)

      It's long past time that Obama started looking backward and not forward. We need some justice, and some perps frog-marched in orange jump-suits.

  •  From the perspective of one (0+ / 0-)

    who has to go to the dreaded grocery store on a regular basis, I'd say inflation has been happening for at least 15 years. A decent loaf of bread costs $4.00 and butter is $3.50-$4.00/lb. now. Along with the obvious cost increases, [I can keep prices in my head, don't ask me why, they get in there and stay] there have also been sneaky changes in packaging. Try to get a half gallon of ice cream, you can't. It's now 1.75 quarts, but the price is higher. Tuna fish cans are the same size but no longer contain 6oz of tuna fish. Big retailers like Walmart get manufacturers to custom size volumes in products like cereal, so they market the same size box, with less in it and people think they are getting a deal. OR, a 10 lb. bag of sugar is $4.79, while a 5 lb bag is $1.99. I know, I know, prices are marked, but seriously? I can do maths quite easily in my head, but what about people that can't? Or when they break down the price per weight/volume into oz.......not hard for me, but this is food!

    I simply get mad and buy something else or go elsewhere. I'm in a fairly dense area and have lots of choices close by. But it's getting harder to navigate and get reasonable prices now. I went out Easter afternoon to get some shopping done and I was out of mayonnaise, a quart and half jar was...omg....$7.29!!! This was at a reasonable grocery store, not Sheetz or 7-11. The foods mentioned are not luxury items. This is insane. I don't go anywhere unless I have to, and I'm buying less and less. I have to believe I'm not the only one, so at some point businesses are going to be looking at less traffic and contracted spending patterns or they already are and are resorting to less than savory sales practices as I noted above.

    This model of large corporations sucking out the baseline economy is not sustainable. Already the states are being drained because of low employment and foreclosures. We are very close to having the whole deal go down, and not because the resources and commodities and labor are not available, but because there is too much of a disparity in income levels and actual use of money for it to go on. It's like playing Monopoly and one player has all the money, game over.

    So do you really think our leaders are misunderstanding? There are surely a lot of dim bulbs in the House. I detest Obama's financial cadre, but do you think they are out of their depth, or they know what they're doing and intend to do it?

    •  They don't get it (0+ / 0-)

      I do honestly think that most of them don't get it.  Our politicians and leaders have fallen hook, line, and sinker for the neoliberal agenda.  They honestly think lower taxes for the rich, and austerity for the rest of us will somehow help the economy.

      Our Dime Understanding the U.S. Budget

      by maddogg on Thu May 05, 2011 at 08:52:26 AM PDT

      [ Parent ]

      •  I really don't think Neoliberal Agenda is an (0+ / 0-)

        accurate descriptor. Neofeudal would be better. We should call it what it is, concentration of money to a point of stagnation at the top. There's always been a certain amount of this and it has been the model from primitive tribes to European monarchies and we had an admitted element of it at our inception which survives to this day, along with the noveau riche that got lucky along the way. But I very much dislike the "neoliberal" moniker as a working term and even less as a persuasive vehicle if you are wanting to inform and educate.

        I'm pretty well educated in a broad array of topics, if not formally credited by some institution, but I have studied a smattering of economics and I can see that the system we have been laboring under certainly isn't any free market where  things equalize all by themselves. I also don't think our leaders have fallen for anything, but rather they were purchased. On subjects both economic and not, they blatantly lie, on camera, repeatedly, unashamedly, still, right now........

        But back to Neofeudalism....at least there was some sort of tribalism and a need to keep the members of same at a certain level of subsistence. Some "Chiefs" are probably better than others of course but on average, in order to maintain the position, things have to be managed and an effort made  to keep an equilibrium. This is where territory comes into play. Our Chiefs are being manipulated by entities that have no borders and they no longer are concerned with [or dependent upon] the reasonable husbandry of their tribe. I'm obviously talking about corporations and other vehicles that siphon money from the economy and avoid contributing by being able to remove themselves from behaving within this "territory's" laws or by purchasing the laws outright. They're quite like pirates actually. They hit land, disembark and steal, then they sail off to some Caribbean Island to stash their loot..........literally.

        My point is, there are all sorts of illustrative analogies. And they're all very simple. So I refuse to believe that 'our leaders' are in the dark.

      •  I think a lot of them don't get it (1+ / 0-)
        Recommended by:
        maddogg

        But I also think that most Republicans and all too many Democrats are concerned with doing things for their corporate constituencies, and that they use neo-liberal ideology as a convenient rationale for doing so, without worrying whether the shibboleths they express are true or not.

        A lot of our politicians think that it's not about reality; only about perception and shaping it with funds from the wealthy and the corporations.

        Having said that it's also true that we need to get MMT communicated and understood by as many people as possible. There are people of good will out there who honestly think that the US has a deficit/debt problem. If we can explain to them why that's not true; then we can get them to support progressive solutions that need Federal spending like Medicare for All and federal Job Guarantees.

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