Thursday, July 26, 2012

Krugman, Delong and Inflation

Quite a few commenters and correspondents have asked me what I think of the latest blast, "What Chicago Doesn't Know" from Krugman and the obliquely-titled "The need for a higher rate of increase in prices" from Brad DeLong.

Yes, I've been worried for some time that our current debt could lead to inflation. And yes, that inflation has so far not happened, and US government interest rates remain low.

Well, they made fun of Friedman when he said in 1968 that inflation was coming. They made fun of Greenspan when he said in 1996 that stocks seemed awfully high, and stocks went up for a few more years. They made fun of Shiller when he said in 2005 that house prices looked awfully high, and they went up for a few more years. Greek interest rates were really low in 2007.

Krugman asks whether I have realized I have the "wrong model." My model is arithmetic.

The Federal Government has about $15 trillion of formal Federal debt outstanding. It has uncountable trillions more unfunded promises and credit guarantees. Right now it takes in about $1.5 trillion and spends about $3 trillion a year.

We must, by arithmetic, either pay off this debt, default on it, or inflate it away. Which will we do?

I hope we pay it off. The only hope for paying it off is to return promptly to strong long-run growth, and to reform entitlements. Doubling Federal revenues by raising income tax rates on "the rich," or by cutting discretionary spending by more than $1.5 trillion per year, forever, seem unlikely.  That's arithmetic too.

But I'm not optimistic. Growth economics is unanimous: You get such growth only from higher productivity, and from letting new innovative competitors dethrone established interests. That's not where our economy is going. Keynesian stimulus doesn't give 10 or 20 years of sustained growth, even in Krugman's "model." 

Defaulting on the debt means financial catastrophe.* And it doesn't solve the entitlement problem. Bad as our past debts are, our projected deficits are worse. 

I happen to dislike inflation. Krugman and DeLong are all for it. They must have been smoking better weed in the 1970s.  But I notice that lots of people seem to agree with them. So, it seems to me that inflate it away, and print money to pay the bills,  remains a decent possibility. 

That's arithmetic. I wonder which part of arithmetic Krugman would have me abandon.

What Chicago does "know" is scholarship. DeLong cites a transcription from discussion at a long ago conference. Krugman doesn't even bother to have an RA dig up a direct link so he can pretend he's reading anything but DeLong. At Chicago, we take a little time to research what people actually have to say before calling them "numbskulls" on the New York Times' website (Krugman) or less than "half-intelligent" (DeLong).  You know what I think of that. Why you continue to read these guys is a mystery to me.

For those of you  infected with that old-fashioned spirit who want to  read what I really wrote on the subject, let me suggest Inflation and Debt in National Affairs, Understanding Policy in the Great Recession in the European Economic Review, or even an accessible  Wall Street Journal OpEd as a good starting place.

All these sources make it quite clear that I view inflation is a danger, not a forecast. The popping of "bubbles" is hard to predict. We're sitting on an earthquake fault. When or if it goes is anyone's guess.

I also pointed out that inflation can come quickly, as it surprised the Keyensians of the 1970s, and as its quick disappearance surprised them again in the 1980s when the US returned to growth-oriented policies.

You can't repeal arithmetic. That which is unsustainable cannot last.

Update 2: A correspondent reminded me that I forgot the obvious zinger, from Alex Tabarrok.
Paul Krugman (March 11, 2003): …I’m terrified about what will happen to interest rates once financial markets wake up to the implications of skyrocketing budget deficits. …we’re looking at a fiscal crisis that will drive interest rates sky-high….But what’s really scary — what makes a fixed-rate mortgage seem like such a good idea — is the looming threat to the federal government’s solvency. …How will the train wreck play itself out? ….my prediction is that politicians will eventually be tempted to resolve the crisis the way irresponsible governments usually do: by printing money, both to pay current bills and to inflate away debt...
See Alex's post for more, including the Krugman response. I'll promise to hammer away at Romney's budgets just as hard, if his promises do not materialize. 

*Update: I was trying to keep it short (for once), and focused on the Krugman/DeLong affair, but a few commenters pointed out that in my own writing I equate inflation and default, that I've argued that Greece should default, and I've argued for forms of debt that make it easier for the US to default. So.. what's this calamity with default?

At issue here is really what our leaders will choose to do. When they have not chosen to grow, so it's down to default or inflation, will they choose default or inflation? Now, though I've been arguing for a Greek default for almost 3 years now, European leaders clearly consider that a "catastrophe." Yesterday's announcement that the ECB will do anything to "save the euro" -- swallowing the trope that sovereign default means the end of the euro -- is essentially an announcement they'll choose inflation over even Greek default. Let alone France. Or Germany. 

Evean a Greek default will not be painless. A large (we need tens of trillions) and unexpected US default will be financially much more chaotic. All those too big to fail banks holding treasuries go under.  The US loses all its "reserve currency" status. It's a big deal.  The Fed is talking about printing money again to buy mortgages because it doesn't like the current once in a century deal on mortgage rates (for those who can get them). Will the Fed really refuse to monetize in a rollover crisis and force the US to default? In my view, not a chance. 

Finally, as I did point out briefly, a default might help Greece, but our big fiscal problem is the looming entitlements not (just) paying off our stock of existing debt. Defaulting on all the debt doesn't solve that problem. And after  a default, the US will have a lot of trouble borrowing, so it will have to pay for entitlements by just printing more money. So the default won't even stop inflation.

All this is a long way down the road, remember. And a return to growth means none of it has to happen.

To Mr. Krugman, we are sailing in smooth waters, nobody has seen an iceberg yet, so it must be safe, so stoke the boilers.  All I am saying is, there are icebergs out there in the middle of the night. Let's distinguish forecasts from risk management.


  1. Excellent post. PK should take a course in preliminry econ again.

    1. See any inflation yet????

    2. Yeah, inflation has hit the US and Europe really hard.

  2. When an economist appeals to arithmetic, this is generally a bad sign.

    Purely as a matter of arithmetic, there is nothing to prevent us from adding $1.5 trillion to the deficit a year from now until the sun goes supernova. Is that likely? No. But there's nothing mathematically impossible about it. I promise that we won't run out of numbers.

  3. I think it's odd that Krugman and DeLong criticize you for saying there's a risk of inflation (something I would think is undeniable) while they simultaneously advocate for nothing other than higher inflation. Why do they think that it's ridiculous for you to worry about inflation as they promote policies that they hope will lead to higher inflation?

    1. Good point. I should have just said "I'm afraid someone might pay attention to you guys."

    2. In winter I advice my toddlers to wear coats. In summer I advice them to leave their coats at home. Only someone who really, really wants to sees a contradiction.

    3. To avoid deflation....

  4. David,

    What DeLong and Krugman want is slightly higher inflation. What they object to is not a warning of slightly higher inflation, but rather a warning of "a massive run from Treasury debt."

    It could be that slightly higher inflation now will lead to massive inflation later. On the other hand, it's possible that slightly higher inflation now would reduce the risk of massive inflation later, particularly if it helped the economy recover (Australia, for example, has had slightly higher inflation than the U.S. for the past couple of decades; they also haven't had a recession since the early 1990s and thus have a debt/GDP ratio of 23%).

    Maybe DeLong and Krugman are right, and maybe they are wrong. But there is nothing contradictory about what they are saying (nor is there anything that violates arithmetic).

    1. As far as I know, Krugman has recommended inflation targets at least as high as 4% over a 10-year period:

      While that's not the 70's it is pretty high. The higher inflation would exacerbate the US' debt problem. I think the average maturity on US debt is less than 6 years right now, so there would be a massive amount of debt to roll over at higher interest rates. I don't think Krugman or DeLong have been advocating budget cuts. They haven't even been arguing for significantly higher taxes. It seems like you're playing with fire there.

    2. I would have thought that we could all agree that trying to dial in a bit of inflation is fraught with difficulty. Paul Volcker, heading in the other direction, tried to dial back inflation and overshot by a lot, sending the economy into a deep recession when money demand didn't follow forecasts. I can imagine targeting TIPS, but the fact that the market is an unbiased estimator doesn't mean that it's good - even if it's better than any forecast available.

      The chief economist of a regional bank recently told me that they were holding more bank reserves than existed in the entire U.S. banking system in 2007. So where is the inflation? And how much more does the Fed need to pump into the system to get inflation to 4%, but not 13%?

    3. Australia tends to have 3-4% inflation and it seems to work just fine. A higher inflation target wouldn't be my ideal choice, but there's no reason to think that maintaining stable 3-4% would be harder than maintaining stable 1-2% inflation, which is what the Fed does now. Certainly the Volcker case (where he wanted lower inflation and got it) is not a counter-example.

      As for the point about interest rates, I think you need to distinguish between real and nominal rates. Typically, the complaint about inflation is that it is bad for creditors, not that it is bad for those with existing debt.

    4. @Lehman

      "The chief economist of a regional bank recently told me that they were holding more bank reserves than existed in the entire U.S. banking system in 2007. So where is the inflation?"

      Where is the inflation? The answer is in your own post.

      If they're holding those reserves, by definition they are not lending those reserves. If those reserves are not being lent, they cannot be spent and bid up prices, nor are they multiplying through fractional reserve.

    5. What John Cochrane was doing was what a blogger on Crooked Timber called the 'Two Step of Terrific Trivality', namely making a claim, and then when pushed, making a very trivial version of a claim. 'Risk of inflation' meaning 'a non-zero probability of slightly higher than desired inflation' is rather different than 'substantial probability of very high and very damaging and hard to control inflation'.

  5. I religiously read this blog as well as Krugman's, and it seems that the two of you agree on more than either of you would like to let on.

    First, you both agree that, in the medium term, the deficit must be addressed, and that cuts in discretionary spending certainly won't do the job.

    On the surface, it seems that you two disagree about what to do now. However, a lot of the disagreement is just about terminology. You, in the wall street journal article posted above, have stated that what matters is the deficit in the medium term; an extra trillion dollars of debt over the next 5 years is unlikely to be the difference between low inflation and out of control high inflation (also, even Milton Friedman and Anna Jacobson Schwartz in "The Great Contraction" strongly argued against fiscal contraction during a recession). Furthermore, you have stated that, given such low interest rates, this is a good time for the government to make investments such as in fixing infrastructure. Krugman would agree, and would call those investments fiscal stimulus (although I appreciate that you two disagree about whether digging a hole and filling it would also be a wise way to spend money now).

    With regard to monetary policy, it seems that both you and Krugman support the Fed becoming a little more creative and continuing to be expansionary. Finally, Krugman often argues for inflation (caused by the Fed, not fiscal profligacy) because it would allow us to have a further negative real interest rate and get closer to the real interest rate suggested by the Taylor Rule (created by John Taylor whom you tend to agree with). Such inflation could be quickly stopped -- as it was in the 80s -- by contractionary monetary policy. This would have a cost of lowering GDP and raising unemployment, but it seems odd to not embrace some inflation to cure a recession just out of the fear of having to create another recession to curb the inflation.

    1. "Such inflation could be quickly stopped -- as it was in the 80s"

      If you weren't there you may not remember just how brutal and damaging the stopping was. We went from boom to bust in a few months. Where I live it took the real estate market four years to bottom and ten years to recover.

      The relative effectiveness of monetary policy at that time does highlight something about economic models: economists state relationships as equalities when they should be inequalities, that is, constraints. Using "=" rather than "<=" or ">=" can lead to false conclusions about causation. The result is that economists may believe a relationship gives them a rigid policy lever they can push on when in fact what they have is a string that can be pulled on to slow down the economy or relax when the string is under tension but which can never be pushed on.

      In 1981 the monetary string was tight and pulling on it had immediate effect and subsequently relaxing on it had immediate effect. Monetary policy is basically in the "limp string" phase now.

    2. Monetary policy has only become ineffective at lowering short-term interest rates because the "risk-free" rate is near zero. However, the Fed could purchase other types of assets, in particular assets with longer maturities (which the Fed has already done somewhat) in order to decrease long-term interest rates which are still significantly above zero. Firms often invest in long-term projects, and so care about long-term rates. If it is believed that inflation is imminent and so a raise in short-term interest rates is coming, then, without intervention by the Fed, long-term interest rates will remain high.

    3. The problem in 1981 was that the tax and spending policy of the Administration (Reagan) was pulling in the opposite direction from the Fed (Volker) while everyone else suffered

  6. "We must, by arithmetic, either pay off this debt, default on it, or inflate it away."

    I'm not an economist but I am pretty good at math (just like you and Noah Smith, I once studied physics). Your statement is not correct as a statement of the arithmetic. So long as the economy grows as fast as or faster than the DEBT, the DEBT can grow indefinitely.

    Even if your statement is true, any solution to the problem is deeply influenced by our beliefs about what the facts are and how the economy works; our value judgments about what would be desireable; and our political assessments of what would be politically feasible. I believe you allow your value system to cloud your judgment about what is feasible.

    The deficit and debt have ballooned as a result of automatic stabilizers like Medicaid and unemployment insurance and the drop in tax revenue from the recession. Spending on infrastructure would have reduced the losses from those factors.

    In addition, there are basically three underlying problems: (1) the criminally irresponsible Bush tax cuts which too many people are now treating as though they were a sacrosanct right rather than a time limited experiment (2) Americans transferring business profits actually earned in America offshore (and creating a fiscal drag on the economy in the process) and (3) rising health care costs. All three of those can and should be addressed by the American electorate. The current Congress has abandoned all pretence of trying to govern for the good of the country.

    1. Funny but tax cuts are always criminal and irresponsible to you but massive run away spending in not.

    2. "We must, by arithmetic, either pay off this debt, default on it, or inflate it away."

      You counter that the debt could be PAID OFF by issuing more debt. That's right, and it does not contradict Professor Cochran's position.

      Of course, your suggestion only works if someone is willing to make the incremental loans. The willingness of people to advance additional funds is a function of the likelihood that they will be paid back. This is precisely what Professor Cochrane is saying. If you continue to borrow at a rate greater than the growth in revenues, at some point you will have borrowed more than you can support, and the additional loans will not be forthcoming (see Greece, for example). Then you default or inflate.

      Your faith that raising taxes, instituting capital controls and rationing healthcare will solve all our problems is so contrary to both theory and experience that it hardly warrants a response.

    3. "Your faith that raising taxes, instituting capital controls and rationing healthcare will solve all our problems is so contrary to both theory and experience that it hardly warrants a response."

      And yet you took the time :-)

      With respect to taxes - I note that the economy did just fine under the Clinton tax regime and did just fine during earlier periods with taxes higher than they are now.

      With respect to capital controls - I did not suggest capital controls. American companies are using transfer pricing to attribute profits flowing from research or business done in America to foreign tax havens. One example is the "Double Irish" arrangement. The US should tighten up on false transfer pricing in all its forms.

      Health care rationing - I never suggested health care rationing. I said rising health care costs had to be addressed - not that health care had to be rationed. The medical system as a whole needs to become much more cost effective. If I were to set a goal for health care in the United States I would shoot for 40% more effective (in terms of coverage and outcomes) at a total cost that is 40% lower.

    4. If you are slice you are an economist. Some are good and some are EVIL /bad. For economics is the study of morality. You know good and evil. Some people want to enslave mankind. Some want to free mankind. Some want to serve two masters. Descartes compared god to a triangle it is all in your mind. (mathematics) the Freemasons call this dualism. The professors call this scholarship / Accadementia. As above so below. I think it is essential for every person who studies western science to have a firm background in Aristotle and Descartes. Without this firm base, a person has no morality. And economics is the study of morals. Good vs evil. This is after all a battle for the minds of men.

    5. A firm goes out of business because the customers want it to go out of business. This is a distinction between theories of value. Who determines the value. The laboror or the customer. The labor theory of value requires a population incapable (slave/uneducated) of determining value. The customer is always right theory requires people to be educated and free to choose. If a firm exists and the people want it to go away. They do so by not investing in it. Now a corrupt government wants the unpopular firm to remain and TERIFFy the people so they take the customers money at the point of a gun. ( leadership by firm convictions as you said before) and gives it to the unpopular firm that the people tried to run out of town. This's inflation or very low interest allow incompetent people to remain or enter the market where they are not welcome. If the people aren't interested they don't invest. You Alexander Hamelton are truly a statesman. Not a free market man. A statesman wants to determine the value of HIS people. Milton Friedman said it best. The ---- are very successful because they find ways of getting around the government. (the statesman who wants to determin their value and does so by TERIFFying the people with artificial human value. A statesman is a slave owner.

    6. We need to get Fogel into this discussion. He has a lot of information on interest rates and arbitrage.

    7. "So long as the economy grows as fast as or faster than the DEBT, the DEBT can grow indefinitely. "

      Which is an unhelpful tautology. Cochrane's possible solution a), pay off the debt via long term growth, goes to the *relevant* question of how much growth is required to maintain or turn around the debt, i.e. arithmetic.

      Visibly the current anemic growth rate is insufficient to zero the deficit, even with an across the board tax hike (to pre Bush). And, should interest rates return to historic levels the current US growth rate will be catastrophically insufficient, forcing solutions b) or c) quite quickly.

  7. Professor, Don't be so sensitive. Krugman refers to the "numbskull quality of Mulligan's argument" and you refer to the "insane idea of fiscal stimulus." This is standard rough and tumble in much of the blogosphere. He thinks you're dumb. You think he's nuts. Big deal.
    But consider addressing the issue. If you don't present a specific mechanism or timeframe for your dire predictions, why should anyone take them seriously?

    1. 'Professor, Don't be so sensitive. Krugman refers to the "numbskull quality of Mulligan's argument" and you refer to the "insane idea of fiscal stimulus."'

      Cochrane made his statement verbally at a round table discussion, naming no one. Krugman makes his outrages in print in the NYT, naming individuals. Is that the same thing?

      "If you don't present a specific mechanism or timeframe for your dire predictions, why should anyone take them seriously?"

      Continue the analogy in the article. If there is insufficient information or know how to predict an earthquake, is there no benefit to knowing that one has built on a fault line? That maybe its not prudent to dismiss the dangers of building a nuclear reactor on tsunami prone seashores because we are unable to predict the "timeframe" of the next tsunami?

    2. Excuse me if I amy ask, but in reading Krugman quite a lot, he would then counter that people have been warning about Japan experiencing this inflation showing up for 20 years, and it hasn't materialized there, and still hasn't.

  8. Isn't the TIPS spread relevant? According to the EMH, that's about the best you're going to do in determining what inflation is down the road. Maybe decades from now things will change, but in the short run you will usually lose betting against the market.

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  10. Inflating your way out of debt sends a message to impressionable young minds that it is ok to break contracts. I believe that when people represent themselves with fake money, they see themselves as fake people. It is certain that others see them as fake people. So it isn't anything personal to break a contract. Especially one so outdated as marriage. It is not personal. Why get so excited when your mate is in your bed with someone else. It's natural. Everyone is doing it.
    One thing is certain
    As our (Alexander Hamelton) so clearly conveys.
    Man is money.
    Money is man.
    And as I say.
    Counterfeit money is counterfeit man.

  11. the FED has complete control over the nominal economy. Why would anyone fear inflation when we can control it?

    I just don't see any risks, but you're a lot smarter than me so maybe I'm missing something.

    1. If the Fed refuses to inflate, the government's options are limited to paying off the debt somehow or defaulting. On our current trajectory paying the debt will not be possible, and defaulting is a last resort. Sure, the Fed *can* control inflation. The question is: will it?

    2. Well it depends on whatever nominal anchor the FED's targeting. Under a 2% inflation target...yeah it will

    3. "the FED has complete control over the nominal economy."

      Until they don't. Those of you who believe in the FRB, believe that a bunch of economists picked by a bunch of politicians, can always out guess the rest of the world. Clearly, you weren't awake in 2008, or 1979, or 1929. The cost of 2008, in lost growth alone is several trillion dollars. It is not an advertisement for trusting the FBR.

  12. I find this post to be very troubling, since there's a lot of things in here that are simply not true.

    "Yes, I've been worried for some time that our current debt could lead to inflation. And yes, that inflation has so far not happened, and US government interest rates remain low."

    You specifically said in that post that policymakers should not be worried about deflation and slow economic growth, but inflation. The last 3 years bears out that the former fears deserved more concern.

    " They made fun of Shiller when he said in 2005 that house prices looked awfully high, and they went up for a few more years"

    At least Krugman, I don't know about DeLong was critical of the economy that we had in the 200's and pointed it was being built on a housing bubble and consumers who were borrowing to consume. It was many on the right who vociferously denied these criticisms, much in an attempt to prop up President Bush.

    "I happen to dislike inflation. Krugman and DeLong are all for it. They must have been smoking better weed in the 1970s"

    What does this mean? The inflation rate should be zero or negative? Or that you have a problem with a specific interest rate. Inflation mostly affects moneyed interests , so I think you're revealing your own political biases. High unemployment and stagnant median wages affects a much a larger share of the population right now, and those things would be aided by elevated inflation.

    "I also pointed out that inflation can come quickly, as it surprised the Keyensians of the 1970s, and as its quick disappearance surprised them again in the 1980s when the US returned to growth-oriented policies.

    This is the most embarrassing part of this post. Volcker, who was appointed by Carter, jacked up interest rates in 1980-1981 to break the back of inflation. And the corresponding oil shock of the 1970's which was followed by the oil glut in the 1980's is what put a damper on inflation.

    1. I don't understand your point...was it the energy which drove growth or was it the monetary policy that cured stagflation?

      are you advocating that we expand the money supply in the hopes of a sharp drop in oil prices?

      I am almost a hundred percent that you are actually in agreement with Professor Cochrane that something else needs to "fuel" growth.

    2. "At least Krugman, I don't know about DeLong was critical of the economy that we had in the 200's and pointed it was being built on a housing bubble"

      Not so fast. Krugman *called for* a housing bubble to be created (2002) before he later blamed Greenspan for creating one (2006).

  13. Prof. Cochrane writes, "I happen to dislike inflation."

    Normally, when a gov't policy injures someone they are entitled to compensation.

    If the gov't has a policy that results in the taking of you house, you are entitled to compensation. If the gov't takes you job, to fight inflation, should you be entitled to compensation?

    What distinctions are there between a house and a job (both, like are property, as just a bundle of contract rights) and a job is much more important to most than a house.

    Should we, and if so how, compensate people who suffer loss or damage when the gov't "fights" inflation.

    For example, when workers are laid off due to lack of demand, suffering all kinds of loses, should they be compensated, and if so, how?

    What about a firm that suffers losses because a customer goes out of business, when it cannot pay higher borrowing costs?

    1. How about when the government steals my savings by inflation and doesn't even give me compensatory interest. The late 70s were brutal, but you could buy 2 year CDs with a coupon of 14%.

    2. not every bad thing that happens has a culpable party behind it.

      On the other hand when unelected officials devalue my savings by inflating, or elected officials affect the same through stimulus will the government print more money to give to me?

    3. Fat man and LAL, which is more important to the public at large: more people working or the value of your savings declining?

    4. the many will always have an interest in stealing from the few...

      often the few are the wealthy but in this case it is anyone who didn't put themselves in debt, anyone who saved for their retirements or college for their kids

      actually im on the wrong side of that debt, and i would love hyperinflation...but i know that i would be no better than an opportunist if it happened and if I ever voted for it I would be little more than a thief (and the kind that has to hide behind other thieves to do it)

  14. Good post.It is weird for me to see how people expect so much from a fiscal stimulus. I dont think that there is a panacea for current crisis.

  15. John,

    I'm unconvinced by your model because you're basing it on the view that the present value of government debt is some kind of discounted sum of the future govt surpluses. This entails - I think you even point this out - that if people think that there's deficits forever, then the value of the debt does zero and inflation spirals. And in your model it happens immediately.

    But we know that tax revenue is, at the end of the day, some fraction of earnings in the economy as a whole. There's some tax rate which maximizes govt revenue, but the economy probably isn't too far away from that. So if there is zero growth and deficits today, then there's an expectation of indefinite deficits.

    Your explanations are much more technical, but (unless I've misunderstood something) that's the essence.

    But - we can see right now that when there's an expectation of very low growth as far as the eye can see, hence indefinite deficits, markets react by buying the government debt, rather than selling it. TIPS have negative yields right now.

    One conclusion - faulty first premise. Our economy just don't value government debt as some kind of discounted sum of a fraction of future primary surpluses.

  16. Could you explain how defaulting on the debt means financial catastrophe? and how inflating the debt is different from partial default, since you pay off in money that's worth less?

  17. Last night, I asked Mr. Cochrane whether he believes in compensating the losers, when the Fed intervenes in the economy to fight inflation and, if so, how.

    The is no doubt that when the fed fights inflation it is implicitly or tacitly picking winners and losers and the winners are the .1%

    Here is CATO learning on this point:

    "If the Fed truly wished to help our economy get back to “normal” then it would allow the free choices of individual borrowers and savers to determine the interest rate. It would also end its implicit practice of picking winners and losers in our economy. Unlike Fed driven changes in asset prices and interest payments, voluntary exchange between savers and borrowers increases the welfare of all parties involved."

    It seems to me that, if you support picking winners and losers, then you have a very strong moral (and legal obligation) to have, at a minimum, a substantial safety net which includes universal health care, free education . . .

    In sum, when very serious people talk about fighting inflation aren't they really talking: "heads the .1% win, tails everyone else looses."

    1. You really don't understand the idea of interest. People normally find young people interesting. Once they get over a certain age everyone naturally looses interest. That is a natural rate of interest. Since your education began and ended with Hobbs you missed this. Darwin called it the natural rate of selection. (sexual selection) read descent if man. Interest is much more than the rate it can compound. In our schools The children are deliberately lied to so they will have faith in the governmern who damages them without any interest in compensating them for their lac of knowledge. Interest is mathematically deliberately disinteresting because the way it is taught isn't interesting. CONSPIRACY. You are the victim of conspiracy and you aren't interested because like Darwin points out about domesticated animals. THEY LOOSE INTEREST IN BEING FREE.

    2. Domestic animals no longer have an interest in nature. This is called a natural rate of interest. With domestic animals it is ZERO. With wild animals the natural rate of interest is very high. Sharks have a very high rate of interest.

  18. Great post, Prof. Cochrane.

    It's all a weird game to Krugman/DeLong. They personally attack people they see as "opponents," and then (as per some of the above comments) their readers swoop in to scold you for taking offense to something that was intended to offend. They poison the discussion with their antics.

    You write that you don't know why I read those guys. I don't. I read a lot of people I disagree with, but I refuse to read people who won't even participate in an honest discussion.

    So, good for you.

  19. The problem with all this discussion of arithmetic (not to mention the implicit moralising about inflation) is that so far all Cochrane's predictions of runs on our debt, bond rates going through the roof, etc etc have proved, lets say overblown. The guy holding up the sign saying "The world is coming to an end" may be proved right but in the meantime we have to deal with something more material.

    1. I do not disagree that "in the meantime we have to deal with something more material". Dr. Cochrane has outlined in this blog his belief that our economic doldrums are due to micro not macro issues and to solve them we require micro solutions (see any post on "shock liberalization"). While no inflation disaster has not yet materialized, the argument is whether the cost of increased risk and uncertainty outweigh the seemingly muted benefits. For this argument as it pertains to monetary policy see Dr. Taylor's blog.

  20. "....and as its quick disappearance surprised them again in the 1980s when the US returned to growth-oriented policies."

    The Federal debt tripled just in the time that Reagan was in office. To do the equivalent, we need to add $1 trillion to the annual deficit beginning right now. Sounds to me like you and Krugman want the same thing. Wouldn't bother me at all. Of course, the way things are right now doesn't bother me either.

    Thanks to Profs Cochrane and Krugman for all the LuLz ;)

  21. John, in order to do risk management, one first has to have some model to measure risk. What is risk? for example, policies that lower growth are risky. Ok, so how do we increase growth? Does it make sense to slash government spending in the face of a depressed economy? What does that do to growth? You say let's remove bad regulation. Ok, a lot of bad regulation is on the state level. Say licensing requirements for cutting hair in Illinois. How can Federal government remove this bad regulation? Given that vast majority of such bad regulations are local, does Federal government throw up its hands and do nothing?

  22. The point is that millions of us have suffered large financial setbacks even though we played by conservative pre-bubble rules! As long as finance is allowed to monetize the future value of every possible asset and commodity, and to skim that value into its pockets in cash today, inflation is basically impossible! It's already been realized as quarterly profits. That means we should fear deflation as people realize there's no more money to be made from these assets. And leaving aside the supply/demand effects of weather on agriculture; thus food, clothing and shelter price increases; that's exactly what we have.

  23. George McCandless and Warren Webber found:

    1) Growth rates of the money supply and the general price level are highly correlated for all three money definitions, for the full sample of countries, and for both subsamples.

    2) The growth rates of money and real output are not correlated, except for a subsample of countries in the Organisation for Economic Co-operation and Development, where these growth rates are positively correlated.

    3) The rate of inflation and the growth rate of real output are essentially uncorrelated.

    Jacob Mincer always would remind us to "look out the window."


  24. This comment has been removed by a blog administrator.

    1. Comment removed for insulting language, which I missed the first time around.

  25. your analysis would be true if US government bonds were not the safest financial asset in the world, and the dollar the world's reserve currency. the demand for such assets is thus normally very high. in a world where growth seems to be slowing all over that demand is even higher.
    so no, there's no inflation anywhere on the horizon

    but i'm curious. for how long does inflation have to fail to materialize before you see the need to reevaluate your analytic framework?

  26. "All I am saying is, there are icebergs out there in the middle of the night"

    The real tradeoff right now is between a broken engine (high unemployment) and a potential iceberg (which may or may not exist). The sensible risk policy would be to fix the broken engine first and keep vigil for icebergs. Maybe you should do a post on addressing the short term instead of just pontification about potential long term issues. Or a post that puts everything in context.

  27. "I happen to dislike inflation. Krugman and DeLong are all for it." What do you think is an appropriate level of inflation 0%? 1%? 2%?
    i don't think Krugman and DeLong are arguig for hyperinflation. I don't think they even arguig for 10% inflation. Just a little higher inflation than we currently have
    Wouldn't you agree that the optimal rate of inflation depends on the particualr situation the economy is going through?? do you think it should always be 2%
    and what if a bit higher inflation could alleviate the unemployment rate??

    1. Inflation is a very bad antidote to unemployment. I lived many years in Argentina, there you get 25% inflation every year. At first it was a little, then a little was not enough, because inflation can lower unemployment as long as someone is fooled. But people can not be fooled forever, so they adjust. In Argentina, wages are raised three times every year to catch up with inflation. The result: the financial system is inexistent. Forget about a mortgage, you wanna buy a house, put cash in the table (literally)
      Cochrane has it right when he says that the issue is GROWTH. The economy needs to GROW, but some liberals hate rich people too much to see this. If the economy GROWS, you have more money to help the poor, provide health care, whatever. If the president says "I can afford to pay more taxes because its fair" capital runs for his life. No one wants to pay more taxes. It might be very romantic, but investors are scared, they see in Obama a guy who is after their wealth.

  28. You (and Tabarrok) reveal once again your obtuseness about Keynes and the various schools spun from him (Old, New, Minsky-Fisher, & Australian) with this "gotcha quote" from Krugman criticizing Bush in 2003 for creating a huge structural deficit with his tax cuts while engaging in two foreign wars demonstrates it. As another economist once said, when "the facts change, I change my opinion, what do you do sir?" The economy was growing in 2003 with a huge housing bubble that was about reach the fever pitch stage. We Keynesians have always argued that when economic growth is near or above trend, that is the time for Government austerity, reducing spending when it is optional, and raising taxes if you have to spend money on wars. Since it hurts your eyes to read Keynes or Krugman, perhaps you can tolerate wikepedia.

    We now face a world wide labor/over investment surplus with a desperate hunger for safe assets and falling demand, with economic growth well below the old trend. Factually, the situations between December 2003 and August 2012 are different. See

    And when Romney runs his far bigger deficits when 1) he cuts taxes as planned on capital gains and corporations 2) increases defense spending to 4% of GDP, 3) starts his war in the Middle East (from Syria to Iran), and 4) his cuts in entitlements and income security (unemployment compensation and the latest bete noire of the right, food stamps - nothing like starving kids to encourage the others), I some how imagine you will find a way to write article in the Wall Street Journal that the deficits don't matter or are all someone else's fault.)

    1. Ok, right, cutting entitlements will cause "far bigger deficits". The problem is indeed arithmetic.

    2. They are not entitlements, they are earned benefits, and like Heston said about the cold dead hand thing . . .

  29. In his blog Paul Krugman makes this point in response to Professor Cochrane's post:

    "For the most part, however, the economists who got it wrong [said something] . . . along the lines      of 'if we have a massive increase in the monetary base and continue running trillion-dollar deficits,    we’re going to see soaring inflation and interest rates'.

    But here’s the thing: the conditions for their prediction have been met. The monetary base has       more than tripled; trillion-dollar deficits have gone on for years. I suppose you could offer some        explanation in terms of other factors for the failure of these events to produce the predicted results      — but I don’t see the Cochranes etc. doing that.

         The point is that it’s not a very good excuse to say that you didn’t specifically predict runaway      inflation if you gave an 'if-then' story and your if came to pass without your then."

  30. What happens when software and hardware become 100x cheaper, and a lot of the cost of medical care goes way, way down

    I imagine everyone here has had their blood pressure taken: a highly trained, $ person wraps a cuff around your has to be that that process can get 10x cheaper.

    In other words, the "entitlement" crisis is another phony republican scare tactic whoose sole purpoise is to enrich the already wealthy.

    Also, you may not realize this, but much higher taxes on the upper ~~ 0.1% will increase growth (!)
    if you live in the real world, it is easy to see this: when marginal rates on income are >80%, the CEO, instead of distorting the entire activity of hte company to his or her personal benefit (as happens now), actually runs the company to make a product

    home builders, instead of focusing on a few small, $$, high margin homes, build better lower cost housing for the middle class, which means more money is left to said middle class for education, investment, etc etc

  31. Cochrane: "They made fun of Shiller when he said in 2005 that house prices looked awfully high, and they went up for a few more years. "

    Delong: "I gotta interrupt again: Who are the "they" who were making fun of Shiller when he said that house prices looked awfully high and that expected returns from housing were negative as it looked like the housing bubble would collapse over the medium term? Was one of them John Cochrane, denying that expected returns on a positive-beta asset like housing could ever be negative?"


    The link he gives is:

  32. The way Delong also put it was that TIPS are saying and have been saying that the markets don't expect much in the way of inflation. Now, this might be a market failure, or markets working in odd ways, but if so Professor Cochrane needs to explain that.

  33. There is no hurry about paying it off, which means there is no hurry about inflating it away. At 2%/yr., inflation is not a problem for anyone who doesn't keep his money under his mattress, so "inflate it away" becomes a perfectly innocuous solution.

    The arithmetic is fine. It's the pejorative, moralistic "inflate it away" argument by connotation that holds no water.


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