I'm in good company

How the banking system is creating a two-way inflation in an economy by Ahmed Mehedi Nizam 

From the abstract:

Here we argue that due to the difference between real GDP growth rate and nominal deposit rate, a demand pull inflation is induced into the economy. On the other hand, due to the difference between real GDP growth rate and nominal lending rate, a cost push inflation is created.

Caught my eye right away. Allow me to present more of Nizam's idea by quoting brief portions from the Introduction:

We propose a new model that describes the role of the banking system in creating a two-way inflation in an economy. According to the proposed model, when the nominal deposit interest rate of the bank is set to a value which is higher than the underlying real GDP growth rate then the money in the depositors’ account grows faster than the goods in the real sector. So, it will lead to too much money chasing too few goods type of scenario which eventually shifts the aggregate demand curve upward. Upward shift of the aggregate demand curve results into a demand pull inflation and an inflationary gap in output...

On the other hand, when the borrowers (investors) are charged at a rate higher than the real GDP growth rate, they (borrowers/investors) have to pay more money than they actually earn by investing the borrowed fund into the real sector. As interest expense is usually considered to be a cost of production ..., a rise in interest expense on per unit of produced goods results into an upward shift of the aggregate supply curve. As the supply curve shifts upward, equilibrium is achieved at a higher general price level resulting into a cost-push inflation and a recessionary gap in output...

I like the symmetry. In the one case, Nizam considers interest on deposits; in the other, interest on loans. I like also that his model explains both demand-pull and cost-push inflation. And, of course, I find his model satisfying because it highlights interest cost as a driver of cost-push inflation, which is the story I've been telling a lot lately.

I should point out that in both the demand-pull and cost-push sections quoted above, Nizam considers interest rates that are higher than the real GDP growth rate, leading to inflation. I didn't quote it, but in both sections he also considers interest rates that are lower than the real GDP growth rate. The outcome he finds, in both cases, is deflation. Again, the symmetry is satisfying.

The next point Nizam makes is this:

Apart from nominal deposit and lending rate, we also consider the total volume of deposit and credit in the banking system in establishing the relationship between interest rate and inflation. Because, if the amount of deposit and credit in the banking channel is not substantial as compared to the overall size of the economy then the causality running from nominal interest rate to inflation becomes weak.

And I'm sitting here screaming YES, EXACTLY!

1. The "total volume of credit" in the banking system is total accumulated debt in the banking system.
2. If accumulated debt is not substantial, relative to the size of the economy, then the impact on inflation (and other things) is weak.
3. But if accumulated debt is substantial, relative to the size of the economy, then the impact on inflation and other things is substantial.

To be sure, Nizam is careful and specific, referring to "the total volume of deposit and credit in the banking system" and I'm just talking about debt, the debt, all the debt, what do I know. But we agree that you don't just look at the interest rate. We agree that you also have to look at the amount of money on which interest comes due. And we agree on the importance of counting the total volume of it.

"If the rate of interest is constant while the accumulation of debt doubles relative to GDP, the cost of interest doubles, relative to GDP."  -- Arthurian