Grumpy Monetary Theory

John Cochrane writes,

The value of money is set by how much there is vs how much people expect the government to soak up via taxes — or bond sales, backed by credible promises of future taxes.

If the government drops $100 in every voter’s pocket but simultaneously announces “austerity” that taxes are going up $100 tomorrow, even helicopter drops would have no effect.

Read the whole thing. My preferred view is that money is a consensual hallucination. But Cochrane’s views are also worth considering.

7 thoughts on “Grumpy Monetary Theory

  1. If the government creates and hands out $100 to each citizen or permanent resident–roughly $30 billion altogether–and the immediately takes it back in taxes, the effect will be the same as if it simply created $30 billoin for itself. The effect will depend on what it does with the money. If it hoards it there will be no effect; if it spends it (*vastly* more likely!), the effect will be stimulative.

    • Governments do crazy things all the time and a lot of what they do is to prevent us from keeping our eye on the fiscal and monetary balls.

      So, I’m asking myself in that scenario what, exactly, the purpose would be of handing out $100 to take back $100? To increase employment at the IRS? More likely, to give proportionately more to some and to take back proportionately more from others. The name of the game here is political, not macro economics. If you give $100 to 10 voters and take back $1,000 from one voter, that has tremendous effect, just not the kind you are thinking about.

    • If, for example, the government doubled the money supply and kept the new half and bought a lot of stuff, I doubt that would stimulate in the long-term. But I suppose a panic for the exits could be described as stimulating.

  2. It seems to me that all theories about people responding to inflation or disinflation by changing their near term spending behavoir are flawed by the real constraints of people’s lives and the economy.

    What percentage of the median household budget is available to acclerate or put off spending according to price levels? I suspect in many households it is near 0%, and even in very well off households rarely more than 35%.

    So inflation will mostly mean that people consume less output, cutting what is possible to cut. Deflation might mostly mean attempts to ramp up savings, especially for those whose consumption is effectively saturated anyway.

  3. The value of money is set by how much there is vs how much people expect the government to soak up via taxes — or bond sales, backed by credible promises of future taxes.

    The inflation rates for the hard currencies seems to have been trending down in a correlated way since the start of the Great Moderation and are all very low today. If the monetary base and fiscal considerations determine the value of money, then we would expect a lot more volatility and a lot less correlation given the variety of national circumstances.

    Or am I missing something? Perhaps if monetary and fiscal policies and outlooks are ‘healthy enough’, then inflation goes into ‘consensual hallucination’ / ‘self-validating expectation’ mode, but past some point of fiscal deficit crisis goes into ‘insolvency-risk correlated mode’.

    Why favor this explanation over something more parsimonious like Cowen’s claim, which is that central banks are not impotent, they have more ammunition, they could do more to create more inflation, but they have made the decision not to?

    • “Why favor this explanation over something more parsimonious like Cowen’s claim…”

      It is unclear what “this explanation” is, or how “Cowen’s claim” would necessarily be an alternative to that put forward by Cochrane (or Kling). Cohen’s claim (the Fed is not out of ammunition), does not do anything to explain the current low rate of inflation, particularly since the Fed has used more “ammunition” than just about any other time in history. Ditto for the ECB. Whether the claim that Central Banks have “more ammunition” at their disposal doesn’t tell me why inflation rates for the hard currencies have been trending down in the first place.

  4. What is the minimum among of monetary history someone has to know before the fiscal theory of inflation seems totally crazy? Or is it purely a theory of fiat money?

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