Interest Relativity is Perhaps The Most Misunderstood Thing
Nominal units are relative
I have been talking a bit about MMT lately. I guess my main critique is that out of enthusiasm, the tendency is to talk about all the insightful and useful conclusions you get from this theory.
Well, this is all fine for helping people to see how impactful economic ideas can be, but I think in terms of theory, the best approach is to get down to fundamental assumptions. Once people have the tools to think about something effectively, they can build up all the proper conclusions themselves.
In that spirit, one of the most widely not understood basic principles, is what I will call “interest relativity”.
Interest Relativity is Mathematically Equivalent to Classical Newtonian Relativity of Motion
Sometimes we use metaphors as “intuition pumps”. By mapping one idea onto another, that can make it easier to discuss something concretely which we are not used to talking about.
While this can be a very helpful exercise, it is possible for this to be more than just a metaphor. In the case of interest relativity, the relativity of motion in classical Newtonian mechanics is more than just a metaphor, it is the exact same mathematical abstraction.
In the same way that there is no stationary reference frame, there is also no fixed stable unit of value.
The conventional exercise of raising interest rates, would be equivalent to trying to bike backwards on a train, while accelerating the train forward. Not only is it unnecessary, it is directly counterproductive.
Both examples rely on an intermediate reference frame. The math in each case is incredibly simple. In the case of interest rates, it is the fisher equation. In the case of the bike on the train, the groundspeed of the bike is the speed of the bike on the train, minus the speed of the train itself.
Real Rate = Nominal Rate - Inflation
Bike Speed Ground = Bike Speed Train - Train Speed
In the train example, the train is an intermediate reference frame moving counter to the bike’s ground motion, the exact same way inflation creates an intermediate reference frame moving counter to the real rate.
What A Free Floating Currency Means for This Mapping
In the case of a free floating currency, it is like our train is replaced with a massless frictionless skateboard. The intermediate reference frame becomes completely arbitrary when you have a free floating currency. Thus raising nominal interest rates, is not really meaningful, as it is just increasing the speed of our bike relative to the train. In the same way that we can increase the bike’s train speed by accelerating the train backwards, we can increase nominal interest rates, by increasing inflation.
Arguably, a mechanism like interest on reserves, is directly a form of inflation. It is literally performing what is mechanically a stock split or dilution of an accounting unit.
Here is a video of someone demostrating the skill of idling a unicycle on a moving platform, which is directly comparable to what the fed currently does with interest rates:
Pulling the platform backwards may appear to make the unicycle move forwards, but it is pure illusion, as the platform’s motion is completely arbitrary.
MMT Is Not Epistemologically Minimal (even when it is correct)
I do not want to disparage MMT too much, because it has done an excellent job of describing how currencies actually work in the real world. But so long as people add interpretation and speculation, it is not really the most minimal set of principles and assumptions. Thus by talking about a specific principle like interest relativity, we can avoid the unnecessary assumptions typically involved in MMT.
“Currency issuer” gets replaced by “Asset Issuer”
“Government” gets replaced by “Accounting Organizer”
Yes, there are a lot of interesting things with political economy, that tend to center around nation states, but if we want to be epistemologically minimal, we need to talk about polities as any other organizer of an accounting system. Issuing a currency is not so different from issuing shares of a company, or a business issuing a coupon.
By focusing on abstract concepts, we can create a more generalized way to say the same thing. This allows us to talk about the political economy of it in a analytically neutral way, and then the political economy becomes an expression of our social interests, not an underlying inflexible intellectual bias.