Peter Radford has commented on my recent paper The Giant Blunder at the Heart of General Equilibrium Theory.

The comment can be read at We Need our Hutton

Until a couple of years ago I used to regularly post graphs of the monetary measure that I called Corrected Money Supply (CMS). An important part of this measure was that it estimated the amount of precautionary savings held in M1 deposits and subtracted that to arrive at an accurate measure of money. The logic was that such precautionary holdings are not intended to be spent and hence do not qualify as money.

Then in May 2020 the Federal Reserve Board merged savings and other deposits into M1, after which my old measure ceased to work. Recently I discovered that the Fed has a new series for savings deposits (https://fred.stlouisfed.org/series/MDLNM) beginning from June 2020, the month after which it changed its definition of M1.

Using the new series, I subtracted savings deposits from the new M1 to achieve continuity with the old M1 series. The results were quite surprising. In August YoY growth in Corrected Money Supply was running at 40%, suggesting that another rate increase would probably not push the US economy into recession. The graph below shows the figures. It also underlines why monetary aggregates are very important.

I do not believe that increasing interest rates will help reduce inflation. But reducing interest rates to near-zero levels merely inflates asset bubbles without boosting the real economy. Increasing interest rates now will prevent bubbles which then have to be punctured. Nevertheless, the Fed would be advised to moderate the quantum of its rate increases.

My new paper The giant blunder at the heart of General Equilibrium Theory has been published in real-world economics review.

Abstract: Proofs of general equilibrium crucially hinge on establishing the existence of an equilibrium price vector that makes excess demand in all markets equal to zero. This paper shows that the so-called price vector does not meet the definition of vector, and that all proofs of general equilibrium are therefore invalid.

My new paper The mathematics of profit maximisation is incorrect has been published in real-world economics review.

Abstract: Profit maximisation is one of the two main optimising principles of neoclassical economics, the other being utility maximisation. In this paper we draw on Chapter 6 of John Maynard Keynes's General Theory to show that the mathematics of profit maximization is incorrect. We show, moreover, that marginal cost, a variable fundamental to neoclassical economics, cannot be calculated. We explore the implications for sticky prices, increasing returns, the shape of the supply curve, and market clearing. Finally, we argue that an important reason for the failure of neoclassical economics is that while it pays a great deal of attention to the influence of future expectations on present decisions, it completely ignores the past.

The stagflation of the 1970s is widely believed to have heralded the eclipse of Keynesian economics and the rise of monetarism. In a previous post (What caused the stagflation of the 1970s? Answer: Monetarism) I had argued that this was not the case and that the stagflation was directly caused by the monetarist policies of the time.

But there is an even more important question that does not seem to have been answered, or even seriously raised: How could the US have avoided stagflation? Considering our experience in handling the Great Recession and the Covid pandemic and in the light of theoretical advances, especially Modern Monetary Theory, this is a surprising omission.

Through 1974 the price of crude rose by an average of 170% year-on-year, because OPEC raised oil prices. If an oil importer in the US had been importing 1 million barrels of oil at a price of $5 and the price went up to $10 then it would need twice the amount of money it did earlier if it wished to import the same quantity of crude as it had previously. Down the line, those to whom it sold refined oil products would need a greater amount of money to buy the same amount of gasoline, etc that they used to. If money in the economy was not expanded to the required extent, then less crude would be imported from abroad and less gasoline consumed down the line. The result would be a contraction in overall output, or what we would call a recession. This is indeed what happened when the Fed tried to constrict money supply growth.

In hindsight, we can see that the policy was completely wrong. The inflation of the mid-1970s and after was caused by a huge rise in oil prices. The inflation should not have been fought; it needed to be accommodated by an increase in money supply. The question we should really ask is: How should the money supply have been increased? There were many options.

The Fed could have bought financial assets and increased money supply. But as we saw after the Great Recession, if money supply is increased in this manner it tends to stay in the market for financial assets instead of moving into the market for real goods and services. The usual result is an inflation in the price of financial assets, and little more.

The Fed could have printed more money equal to the difference in crude import costs, given it to the importers of crude to pay foreign crude exporters, and in return asked that the domestic price of oil be kept unchanged. Developing countries could not have exercised this option because the willingness of crude exporters to accept newly printed currency depended on the existence of goods and services (or investments) that could be bought with the newly minted currency. Also, it would have amounted to a blanket endorsement of any price increase by OPEC.

Another problem was that domestic oil producers too increased oil prices, though to a lesser extent because of price controls imposed by the Carter administration. They too could have been compensated in the same manner as crude importers but then there would have been no incentive for crude producers, domestic and foreign, to control prices.

But after the experience of the Covid pandemic and the spread of MMT, we know that there was another option. The government could have directly put money into the accounts of ordinary individuals and left it to them to decide whether the money should be entirely spent on higher priced oil and other goods or saved. There would still have been inflation, and given the international price of oil this was inevitable. But the pain would have been mitigated to a great extent and the problems associated with price control could have been avoided.