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Monetary Policy is Not a Bridge
It’s a Shock Absorber
The Disagreement
Mainstream economic theory tends to treat monetary policy as a bridge or a ramp. Raising interest rates can cause an arbitrary amount of deflation, in this view. But if you understand the mechanics of interest rates, this makes little sense.
Background
First of all, what is interest? It is a measure of a financial return for some asset or investment. “Raising interest rates” sounds like you found some assets with a higher rate of return, and so now everyone can enjoy more wealth. But this is not how monetary policy is supposed to work. Rates are viewed as a “price for money”, or similarly, as a filter for what projects are viable, in order to manage demand.
Both these ideas have substantial issues. The first is the “price for money” narrative. What you have to realize, is when we talk about interest as a “price for money”, it is, by definition, a circular price. Interest is the price for money, denominated in money. More specifically, it is the price for money now, in terms of money later. Because prices are relative, if you say an orange is worth two apples, then an apple is worth half an orange. So if you make money today “more expensive”, you are making future money cheaper to buy. This is exactly how interest…
