MMT ignores the role of the demand for money – Latin America proves inflation rate explosions despite finance through MMT approach

Inflation. The data in these tables show that inflation was, eventually, extremely high in the four episodes. In Chile it surpassed 500 percent in 1973; in Peru, it reached hyperinflation levels — it exceeded 7,000 percent in 1990 — and in Venezuela it surpassed 130,000 percent in 2018. The IMF expects inflation in Venezuela to reach the 1,000,000 percent annual mark in 2019. As noted earlier, very high inflation feeds back into the fiscal deficit through the Tanzi‐​Olivera effect. When inflation is very high, indexation tends to become generalized, and wages are adjusted at increasingly shorter intervals. This means that the government wage bill — which in all of these countries was very substantial — increased rapidly, while taxes were assessed and paid based on lagged (and much lower) prices. In all of these cases a collapse in the demand for domestic money (or an increase in velocity) contributed significantly to the explosion of inflation. In Chile, for example, velocity in 1973, at the end of the Allende government, was 24 “times” per year, which was two times higher than the historical pre‐​Allende average of 12 times.23 Interestingly, during the last decade, velocity in Chile has been around 3 times. One of the most serious weaknesses of MMT is that it ignores the role played by the demand for money in macroeconomic outcomes. Economists have known for a long time that, as Patinkin (1965) masterfully emphasized, what matters is the excess supply (demand) in different markets. In his MMT Primer, Wray (2015: 254) declares that he is surprised by the notion that during a hyperinflation economic agents reduce their holdings of domestic money to a minimum. The absence of a prominent role for the demand for money (and changes in velocity) in the theoretical construct of MMT is, indeed, surprising. In Chapter 13 of the General Theory, Keynes explains that people hold money for three motives: transactions‐​motive, precautionary‐​motive, and speculative‐​motives (Keynes 1936: 168). He further argues that the demand for money (or liquidity preference) is a function of the rate of interest. He explicitly writes M = L(r). Economists have known, since at least Irving Fisher, that higher inflation results in higher r. Thus, a rapid increase in inflation will generate a greater excess supply for money, which will be mirrored by an excess demand for goods and bonds (here I am following Patinkin’s analysis); the excess demand for goods, in turn, will put pressure on prices. MMTers believe that because taxes have to be paid in domestic currency the demand for local money cannot decline precipitously. The experiences of the three countries discussed here show that this is not the case. Indeed, and as a large number of economists have pointed out throughout history, when the value of the local currency erodes quickly, holdings of it are reduced to a minimum and velocity increases rapidly.