Mickey Butts interviewed economist John H. Cochrane for Stanford Business: A “Grumpy Economist” Weighs in on Inflation’s Causes — And Its Cures (20 August 2024).
« Cochrane is an economist at Stanford’s Hoover Institution … the author of The Fiscal Theory of the Price Level, and writes a newsletter titled The Grumpy Economist. »
« In a recent paper in the Review of Economic Dynamics, Cochrane argues that higher inflation resulted from the federal government pouring trillions of dollars in stimulus spending into the economy during the pandemic. To prevent future inflation shocks, he says U.S. policymakers must target taxes, spending, and growth and stop relying on rate-setting alone to keep the economy in check. “The Fed is a lot less powerful than people think,” he says. »
Q: « What do you think is behind the pandemic-era burst in inflation and its recent moderation? »
A: « In my analysis, inflation mostly came from the government’s $5 trillion in COVID and post-COVID deficits. The government essentially sent people $5 trillion with no plans to pay the money back. People tried to spend it, driving up prices. The Fed eventually raising interest rates made inflation come down a bit faster than it would have otherwise, but it was going to go away on its own anyway. There is no magic momentum to inflation. Stop pushing, and it stops. »
Q: « You argue that higher inflation did not result from the Fed’s efforts to buy up $4 trillion in government debt from banks during the 2010s, known as quantitative easing (QE). Doesn’t this run counter to conventional economic theories? »
A: «…Money is just another kind of government debt, after all. QE is taking a $20 bill and giving back two fives and a ten. Getting change for the $20 is not going to make people spend a whole lot more. Deficit finance is just giving people $20. Whether they get the $20, or two fives and a ten, doesn’t really matter. They spend it… »
Q: « Was the Fed too slow in responding to rising inflation in 2021? »
A: « Yes. Not even in the 1970s did the Fed wait an entire year to move interest rates after inflation surged. »
Q: « The temptation has been to set interest rates using a simple, preannounced mathematical formula, such as the Taylor Rule, which says that central banks should raise interest rates when inflation increases and lower rates when GDP declines. Does the U.S. need to rely more or less on predictable rules in the future? »
A: «… I think the Fed should not mechanically follow a rule, but rather use rules as a benchmark. Then explain what’s special today that motivates deviating from the rule. Yes, look at inflation and employment, but don’t ignore a huge war, financial crisis, or cyberattack. This is John Taylor’s interpretation of the rule, and I largely agree. »
Q: « The liberal economist Paul Krugman agrees with you that runaway inflation didn’t follow from setting interest rates at zero for decades and that the Fed probably engineered a “soft landing,” which you predicted in 2022 as well. Do you two agree often? »
A: «… We fundamentally disagree on the cause of inflation. He backed the “supply shock” excuse and predicted it would be “transitory.” Supply shocks are relative price movements, not inflation. He’s been all for fiscal stimulus. I think the fiscal stimulus caused the inflation. So there is still plenty to disagree on. »
Q: « Why do you say that coordinated action is necessary on both the fiscal and monetary fronts? »
A: « The Fed alone cannot stop all inflation. The Fed is a lot less powerful than people think. Our fiscal situation is in really bad shape. Markets expect Congress to fix it after they’ve tried everything else, but eventually people will lose faith. I also fear that the next crisis will be like the last one, but bigger. In the next crisis, the government will want to borrow and print maybe $10 trillion to bail out the financial system again, keep businesses and people afloat, and maybe finance a war. But since everyone saw how things turned out last time, we’ll get a big inflation fast. Or a debt crisis, or a default. It can happen, even in the U.S. Then the U.S. can’t borrow enough to meet the needs of the crisis, a genuine catastrophe. »
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