More on the Interest-Income Channel

Last weekend, I wrote about Warren Mosler’s argument that the Fed’s rate hikes could be undermining its effort to bring down inflation. While Mosler is a leading proponent of Modern Monetary Theory (MMT), the notion that “monetary tightening” (conventionally defined as central banks raising interest rates) might add to inflationary pressures isn’t unique to MMT.

Mosler emphasizes the “interest-income channel,” but it’s not the only possible pathway from higher rates ==> higher inflation.¹ And while mainstream economists like Paul Krugman and Olivier Blanchard acknowledge the interest-income channel, they don’t assign it much potency. Mosler does. He points to the fact that that the rate hikes are feeding hundreds of billions of dollars of additional income to bondholders. To get a sense of the numbers we’re talking about, here’s a passage from last week's post:

Compared with its May 2022 estimate, CBO now estimates that over the next 5 years, the federal government will pay out an additional $644 billion in net interest. This isn’t what will be paid out in total over that period. That’s a whopping $3.879 trillion! The $644 billion is the additional amount of net interest CBO thinks the government will end up spending over the next 5 years, mostly because of the Federal Reserve’s aggressive rate hikes.

And here’s a chart from Apollo’s chief economist, Torsten Slok, who just yesterday observed that interest payments on US Treasuries have doubled from around $1B per day before the pandemic to about $2B now.

Mosler points to the stock of US Treasuries held by the public, which as of last week stood at $24.62 trillion. “Debt held by the public” is composed of Treasury Bills, Notes, Bonds, Treasury Inflation-Protected Securities (TIPS), Floating Rate Notes (FRNs), Domestic Series, Foreign Series, State and Local Government Series (SLGS), United States Savings Securities, and a portion of Government Account Series (GAS) securities.²

To be clear, the Fed’s rate hikes aren’t pushing additional interest income into the hands of everyone who holds a portion of the outstanding $24.62T. But the rate hikes are pushing additional interest income into some hands, and that has the potential to push up inflation. Westwood Capital’s Dan Alpert recently showed how investors capture a financial windfall simply by rolling over short-term Treasuries in an era of rising interest rates.

For Mosler’s interest-income channel to drive up prices at the macro level, a substantial amount of that interest income would need to flow into the hands of people who turn around and spend it back into the economy. Here’s how the entire $31.4T is (as of January 2023) held.

So the question is, where—specifically—is the additional interest income going, and how much of it is being spent in ways that support aggregate demand in the United States? Mosler admits that he doesn’t know, but he says “It’s not zero.”

If you’re interested, Warren talked about all of this at length in a recent interview.

Enjoy the rest of your weekend.

1. I wrote about other pathways here, and Joseph Stiglitz talked about how the rate hikes could make inflation worse here.

2. See https://fiscaldata.treasury.gov/datasets/debt-to-the-penny/debt-to-the-penny