Or should I call it Grumpy Monetary Theory? He calls it the fiscal theory of the price level. In a podcast with Tyler Cowen, John Cochrane explains,
the distinction between money and government bonds isn’t that important. What matters is overall government debt and the government’s ability to pay that debt back. And inflation comes when people lose faith in the government’s ability to pay back its debt. They try to get rid of the debt because they know it’s not going to get paid back. What do you do with it? You buy stuff, and that drives up the price of goods and services.
There is more at the link. I will spell out my own version of monetary theory tomorrow. It also downplays the distinction between money and government bonds. But I don’t have the sort of forward-looking consumer behavior that Cochrane uses as the basis for his thinking.
FITS note: Cowen and Cochrane disagree. They appear to me to be steel-manning one another. So they each would earn an S point if this were the season.
Finally, I like what Cochrane has to say about non-profits and about the economic profession. So go read the whole transcript.
Cochrane couldn’t be more correct: “A nonprofit is protected from the market for corporate control. If Stanford is screwing up, you can’t just buy up all the shares, kick out the management, and improve it. That’s also part of the secret of why hospitals are so screwed up — because they are also protected from that market.
The whole nonprofit business — this is a side issue which we should talk about some time — the nonprofit status in the US has been, like everything else, horribly misused. Now it’s a cover. A lot of it is a cover for getting out of the estate tax and for subsidizing political activity at taxpayer expense.”
Yes, this area is way overdue for serious reform. More fundamentally it is a telling indictment of the Pigouvians who would micromanage the economy via the tax code. One is reminded of Greg Mankiw’s shameless and shameful defense of the big-endowment universities when a minuscule tax on their capital gains was proposed.
And of course Cochrane is on the right scent with this observation as well:
“What is there about our political system that is unable to come to these sensible cause-and-effect, obvious solutions to obvious problems?
Interesting — America had this amazing flowering of political engineering in 1790, and we seem to have just lived in the building ever since and not really done a great job of thinking about it.
In any scientific pursuit, you need to start with answers, not with questions. If you start with big questions, you’re never going to get anywhere. I think I have some answers, but that certainly strikes me as a question. How can we better engineer our political organization — kind of a constitutional moment — to produce the better economic outcomes that you and I know are there and just sitting —“
This constitutional moment won’t happen of course until a re-energized populist movement forces an Article V constitutional convention and gets down fundamental reforms. Our garbage media, our garbage universities, our garbage courts and our garbage bureaucracy are innately incompetent at any sort of meaningful reform.
My favorite line: “I still don’t know that I have a good story for the inflation of ’70s and ’80s, which is a gaping hole.” Well said. What does he have a good story for?
Compare Scott Sumner here https://www.themoneyillusion.com/arnold-kling-on-monetary-and-fiscal-policy/:
Remember LBJ raising taxes and pushing the budget into surplus in 1968 in order to bring down inflation? How’d that work out? Budget deficits were pretty low in the 1970s, as a share of GDP. What happened to inflation? Then inflation fell as Reagan pushed the deficit much higher. A big reduction in the budget deficit from $1061 billion in calendar 2012 to $561 in calendar 2013 should have slowed the economy according to the fiscal dominance theory. Instead NGDP growth sped up in 2013. Then the deficit ballooned to a trillion dollars in 2019, and yet inflation stayed below 2%.
The classic quantity approach has a solid story for this major, recent monetary outcome and Cochrane doesn’t. Maybe his theory doesn’t have a “gaping hole”, maybe it is just wrong.
“And inflation comes when people lose faith in the government’s ability to pay back its debt.”
Which “people” are likely to matter here?
Behaviorally I think Cochrane is 180 degrees wrong, the more uncertain the future is the less you consume now and the more you try to save. Believing that governments won’t repay debts might make you sell their bonds but that doesn’t translate into more spending. It will for most translate into less spending, empirically consumption crashes during high inflation, not increases. A better description is that people start dumping bonds and buying whatever other hard assets they can find- gold, real estate, stocks etc and continue dumping whatever currency they earn and can save into those assets. High inflation occurs when you have to offer high prices to get people to part with assets.
“You buy stuff, and that drives up the price of goods and services.”
Nothing could be further from the truth and it makes me question all of Cochrane’s work. You buy other assets…end of story.
You buy other assets until the dollar price inhibits you. The inflation eventually goes beyond “hard assets” and end up, first, in durable consumables like liquor, for example.
Or do we just create new assets (Bitcoin)?
So many good quotes from John:
we’re playing the game that Hayek told us not to play, of sitting around a coffee table and say what forces are moving prices around. There’s all sorts of speculation about it. We can have fun. I can give you the five theories. I don’t believe in any of them.
Yet it’s so much fun – intellectual fun (for we, the intellectually superior.)
Why low interest? Low growth.
a low-growth economy has less opportunities for investment.
On EMT (efficient markets):
If everybody indexed, markets couldn’t be efficient because no one’s out there getting the information that makes markets efficient.
John doesn’t say it, but index-investors are free-riding on the trading risk of those trading.
In recessions people get scared:
It’s people get scared. They don’t want to hold risky assets. They want to hold safe assets.
For now and the near and mid-term future, if US Treasuries are not safe, no world asset is safe. Thus no hyperinflation over USD. 2025 99% 2030 95%
Fiscal Policy, too much gov’t debt – what do debt holders do?:
They try to get rid of the debt because they know it’s not going to get paid back. What do you do with it? You buy stuff, and that drives up the price of goods and services.
Grey’s Law – no Hyperinflation without shortages in food
My claim is that if there is enough food produced, no panic buying of food. The rich who “buy stuff” do not buy more food – it goes bad. If there’s enough food, there will NOT be hyperinflation. [Prove me wrong]
For gov’t: if you can borrow more, and the interest rates don’t go up, then government debt is a money machine.
This is the Modern Monetary Theory (which Arnold critiques.)
Why not gov’t borrow more, forever?
If it isn’t going to be repaid by taxes, people are still going to try to get rid of that government debt and they’ll cause inflation.
What happens when “Bond Markets” say “no thanks” to more US debt?
Bond markets look at $25 trillion of US debt and then in the next crisis, we want to borrow another $10 trillion. They say, “Sorry, guys, we’re done.” And now, everything that looked sustainable is all of a sudden not sustainable, and the r’s that were less than g are suddenly a lot bigger than g.
There are no Bond Markets – markets don’t exist; only people see debt.
Rich people exist, and are decision makers, and choose to buy bonds or not.
“Bond Market” is shorthand for rich people making buy & sell decisions about gov’t bonds.
…You’re sitting on a powder keg, and a powder keg, a run, a crisis — if you could predict it happening, it would already have happened. It’s one of those unstable situations.
The rich people decide. And they will NOT decide to blow up their own wealth and power … unless they have some other source of wealth and investment.
2008 TARP bailout for rich investors making a huge financial mistake. Lesson – the rich will use the gov’t to stay rich (altho some might go bankrupt).
Even in an efficient market, there’s such a thing as a bank run. Everything looks fine until all of a sudden, the bank run, the black swan. That’s the mechanism of the inflation. It can look fine. Interest rates never forecast inflation. …
We’re sitting on a powder keg. We’re sitting on the possibility of a run, a crisis, which would be a sharp unforecast inflation,
Today US Treasuries are both store of value and in their near equivalent USD cash form, the medium of exchange for world trade, and world wealth.
There is no substitute.
Until there is a substitute, the rich decision makers will not allow a crisis to ruin the money
printingmaking.They are rich owners of Apple & Alphabet – when those shares hyperinflate in price, the rich get richer much faster. As the US national debt goes up, financial asset prices are hyperinflating – and there’s no historical reason to stop stock prices from going up.
P/E (price/earnings) of 50; 80; 150…
The stock market can only be “too high” when rich owners can sell AND buy something else.
And today’s rich are the bigger investors in crypto.
If crypto could be relied upon, it could, like the Euro or the Renminbi/Yuan be a global substitute for USD – but it could also join the hyperinflation of rich investor assets.
Great conversation.
“Why low interest? Low growth.
a low-growth economy has less opportunities for investment. ”
The arrow of causation could also run the other way, which is my guess. Fewer opportunities for investment means low rates and low growth.
It almost certainly does run the other way, lower interest rates allow indebted firms to continue indefinitely keeping resources and market share out of the hands of smaller growing companies.
Right
One thing has always bothered me about Cochrane’s FTPL.
OK, so the Fed (or the Bank of Japan) buys back sovereign bonds.
This makes it much more likely the government can meet debt payments, no?
The Dallas Fed say so,
“The (FTPL) theory implies that the quantitative easing programs, which created money to purchase mortgage-backed securities from the public, preserved price stability because that money is backed by the returns from real estate investments. Similarly, Germany restored price stability after its interwar hyperinflation with its real-estate-backed currency.”—Dallas Fed, “Inflation Is Not Always and Everywhere a Monetary Phenomenon” by Antonella Tutino and Carlos E.J.M. Zarazaga.
By this version of FTPL, it appears that some monetizing of government debt (central bank purchases of Treasuries), counter-intuitively, is also anti-inflationary. The government is less indebted, more able to meet obligations.
I never see anyone answer this oddity.
The other oddity is that some famous economists, such as Michael Woodford, say federal deficits combined with QE are helicopter drops, and others say it is not.
You know, when there is not even agreement on the ground rules…how do you play the game?
The ability to repay debt is typically behavioral not mathematical. US federal tax receipts run around 20% of GDP, so they can theoretically reduce debt levels starting at 100% of GDP as long as their interest rate is <20%, and that is with zero GDP growth. Add in a few percentage points of GDP growth and its higher, even with 200% debt to GDP the federal government can decrease its debt load at interest rates 11% or less (assuming something like 2% growth). So we are no where near the theoretical limits of debt servicing, the issues are behavioral, the US government isn’t going to cut spending to zero, the issue with CBs monetizing debt is that it completely ends the hope that governments will reduce debt to GDP at all. Observationally it nearly guarantees that governments will increase debt loads while CBs mop up the bonds.
If your alcoholic uncle asks for money and you give it to him unconditionally you can expect him to spend it on booze. If you give it to him conditional on him going to rehab you have a chance of it not being spent on booze. Current central bank policy is to drive you uncle to the liquor store and shove him through the doors with cash stuffed in his pockets. Talking about hypothetical implications of your support enabling him to give up drinking is insane in such a world.
The idea that “inflation comes when people lose faith in the government’s ability to pay back its debt” seems crazy. Isn’t it rather when people lose faith that cash and near cash equivalents will hold their purchasing power until that value can be consumed? (Everyone knows they will lose value over the longer term – look what has happened to dollar purchasing power since we went off gold in 1973.) It has been obvious for a long time that our government will never and can never “pay back its debt” in any meaningful sense. What it can always do is trade fiat currency for its debt. This is what the Fed does; it creates money to buy bonds – bonds which would otherwise fall in value and drag down other assets because bonds are being issued far in excess of global savings. We in fact do have a lot of inflation; it is in asset prices. The interesting question is why it isn’t more reflected in consumer prices. In part it is because the CPI is rigged to hide the large housing cost component.
In part it is because the CPI is rigged to hide the large housing cost component.–T.
Somewhat true. Although if we got rid of property zoning, we would get rid of housing cost inflation.
No, it wouldn’t.
There is cheap abundant housing in every single major city, including housing with good physical infrastructure. Go on Zillow and it’s not hard to find.
However, the housing is in bad neighborhoods or bad school zones. It’s actually pretty easy to calculate the price differential and compare it to say the cost of sending kids to private school (which you have to do in a bad neighborhood).
Zoning protects neighborhoods. If you get rid of zoning the neighborhoods fall apart and value is destroyed. You don’t get more “good” housing, you get more bad neighborhoods where the existing housing stock is worth less. This has played out over and over again in so many cities. You build cheap housing, the underclass move in, the neighborhood goes bad, housing values collapse, and anyone with enough income flees. There should be enough experiential data on this to put this fantasy to rest.
If you are serious about reducing housing costs you need to get serious about public order and schools. If and when you pass reforms that are likely to alleviate those concerns, the relaxing of zoning laws might lead to lower housing cost (including related costs like schooling and safety).