As I wrote a few weeks ago, if central banks really do want to be reducing inflation, then raising their policy rates is the wrong tool for doing so. What they should be doing is, as the Bank of England had been proposing, speeding up the process of QT, and, thereby, reducing the amount of liquidity in the system. It is the devaluation of the currency, the standard of prices, that is the cause of inflation, and that devaluation arises from an excess of liquidity. Even so, such a reduction would not have an immediate effect, because it takes around 2 years for changes to work their way through the system, and become manifest in prices.
The cause of higher interest rates is an increase in the demand for money-capital relative to its supply. Money-capital is not the same thing as money, or money tokens/currency. Money-capital is the money form of capital, in the circuit of industrial capital. It is the money that is transformed into productive-capital, at the start of the circuit, and also, the money that is the realised form of the value of commodities at the end of that circuit, resolving into the value of the consumed constant capital (raw materials, wear and tear of fixed capital), the value of labour-power (wages), and the surplus value produced (profit, rent, interest and taxes).
The money which is the equivalent form of the value of consumed constant capital, is thrown back into the circuit to replace the consumed constant capital, on a like for like basis, and the same applies to the money that is the equivalent form of the variable-capital (wages), to replace the consumed labour-power. This is where the monetary demand for constant and variable-capital comes from. The money form of the surplus value, as profits, goes to fund the consumption of the capitalists, but some of it also forms a fund for capital accumulation, as they do not need to use all of the profits (interest, rent and taxes) for personal consumption. This portion of realised profits forms the supply of additional money-capital thrown into money markets to fund the borrowing required to finance capital accumulation (investment). It is where the demand for consumption goods for capitalists, and accumulation of additional constant and variable capital comes from.
If this latter supply from realised profits rises faster than the demand for it for investment, then interest rates fall, and vice versa. In addition to this source of money-capital, additional money capital can be drawn into the money markets from savings, for example, banks may encourage money held in private hands to be deposited with them, and by pooling them, the banks can throw them into money markets as additional supply. Firms, in the prices they charge for commodities obtain an amount equivalent to the value of wear and tear of fixed capital, which forms a reserve fund for when they need to physically replace it, but they can use these reserve funds, instead, to accumulate additional capital, now.
If wages are rising, that would reduce surplus value, but by increasing liquidity, central banks enable firms to increase prices, and so, firms are able to raise nominal prices to compensate for the higher wages, and avoid a reduction in nominal profits. This is the basis of a price-wage spiral. If, central banks do not increase liquidity, then, as wages rise, because prices cannot rise, the result is reduced profit share. If aggregate demand is rising in the economy, which is invariably the case when wages are rising, firms seek to accumulate capital, to grab their share of this rising demand. Increased wages also stimulate a further rise in aggregate demand.
That is why talk by financial pundits about employment being a lagging indicator, in current conditions, is wrong. In current conditions, rising employment levels are a leading indicator, because it means, more wages being received (both from more workers employed, and higher wages per worker), and so greater future demand in the economy. This is why they have so badly mistaken what is going on, and failed to anticipate continued strength in demand. That is not to mention the existence of large savings in the hands of consumers accumulated during two years of lockdowns, still feeding into consumption.
Higher nominal interest rates will not curtail this demand, because a) day to day consumption is financed out of current income/wages, not savings, which are used only for purchase of higher value commodities, and assets, b) even the raised nominal interest rates are way below actual levels of inflation (savings rates at around 1%, whereas inflation is at 10%) so that there is a big incentive to use any existing savings to finance consumption, and so get ahead of rapidly rising prices, and only when nominal interest rates exceed inflation would any such deterrent effect take place, but long before that, the higher nominal interest rates would have cratered asset prices, as the rapidly evolving crash of property prices, and last week's potential gilt crash illustrated.
The supply of additional liquidity cannot reduce interest rates, precisely because money tokens are not money-capital. Excess liquidity causes inflation, and a consequent rise in the general level of prices. If the initial general price level is at an index level of 100, and rises to 200, this only means that the unit of measurement changes, having fallen in half. So, as Marx describes this cannot change the rate of interest. If the demand for money-capital is £100 billion (determined by the prices of productive-capital, means of production and wages), and the required supply of this £100 billion of money-capital results in an interest rate of 6%, this rate is not changed if, after inflation, the demand becomes £200 billion, and so the required supply is also £200 billion.
“Massie laid down more categorically than did Hume, that interest is merely a part of profit. Hume is mainly concerned to show that the value of money makes no difference to the rate of interest, since, given the proportion between interest and money-capital—6 per cent for example, that is, £6, rises or falls in value at the same time as the value of the £100 (and. therefore, of one pound sterling) rises or falls, but the proportion 6 is not affected by this.”
The quantity of money tokens in circulation determines the general level of prices, not the level of interest rates. It doesn't matter whether the demand for money-capital is 100 billion at the start of the circuit (determined by the prices of commodities), and supply of money-capital coming out at the end of the circuit (again determined by the prices of commodities) is 100 billion, or whether, as a result of a change in the general price level, resulting from a devaluation of the standard of prices, these figures are 200 billion. The proportional relation between demand and supply remains unchanged, only the unit of measure has changed.
Nor is it the general level of prices, therefore, that leads to changes in interest rates. However, interest rates do react to inflation, the movement from one general price level to another, higher, general price level. If I lend £1,000 today, at the very least, when I get that £1,000 back, in a year's time, I expect its real value to still be £1,000. If inflation is 10%, then the current value of £1,000, a year from now, is £1,100. So, I would expect to get back at least £1,100, plus whatever the current market rate of interest is. That appears as a higher interest rate, but, really, it is only the requirement to repay the capital sum in real terms. Its like if capital is loaned in the form of a machine. Interest is charged on the money value of the machine, but, the lender also requires compensation for the amount of wear and tear of the machine, during the loan period. Inflation is a kind of wear and tear of the use value of money.
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