Wednesday, November 2, 2022

Ip on FTPL

Greg Ip gives nice coverage of fiscal theory of the price level in the Wall Street Journal.. 

I'm sad he left out Eric Leeper's defining work, which really even more than Sargent and Wallace started modern FTPL. Eric described monetary policy with interest rates, not money supplies, and integrated FTPL with the now dominant new-Keyensian tradition. 

Naturally I'm a bit rankled by 

But FTPL is frustratingly difficult to apply to real life. 


A theory that doesn’t predict inflation but explains it only after the fact by invoking hard-to-measure attitudes isn’t that satisfying, and certainly no better than mainstream macroeconomic models.

Well, that also means no worse than mainstream models. And I was publicly warning of inflation in April 2021, though I'm too much of an academic to make much of one data point. The FTPL analysis of the ZLB is, I think more convincing. 

Yes it would be nice if FTPL could tell you just when too much debt is too much. It would also be nice if the theory of finance could tell you just what a stock should be worth. And it would be nice if any theory, or the Fed itself, did a good job of predicting inflation. 

A nice nugget, 

 fiscal stimulus had some role in pushing inflation up, and as the Fed raises interest rates to combat that inflation, it will worsen deficits. Britain had to abandon deficit-financed tax cuts over fears they would drive inflation and interest rates higher. French Finance Minister Bruno Le Maire recently warned: “Central banks’ restrictive policies are ineffective if public finances continue to expand.”

It seems we're all FTPLers now. 

But I'm whining. For the length it's excellent. This is a hard topic and most journalists get things wrong.  And I am grateful for the publicity.


  1. "Britain had to abandon deficit-financed tax cuts..."

    Britain had to abandon DEBT financed tax cuts.

  2. I've finished my first pass through on the book, though I probably will need to re-read two or three times it to grok everything.

    With respect to applying it, I think this goes for all DSGE models. There are probably two ways to think about practical use: policy analysis and forecasting. By policy analysis, I mean working out scenarios in your head. If the Fed or Congress do X, then what will happen. It takes some familiarity with the models to be able to get some sense of this. Being able to distill this into stories is useful, but there is a bit of knowledge required to be able to understand those stories from the FTPL book.

    For forecasting, whenever I've asked other Economists on Wall Street, they say they don't use it for forecasting. But I'm sure if you look at their econometrics, they bear some similarities to the New Keynesian models that you describe in the FTPL. In this sense, the chapter of the book that estimates a VAR model is very informative. Any improvements you could make to that chapter (I don't know precisely what that would be without re-reading it) could help make it easier for someone to incorporate FTPL into an existing forecasting framework.

    I plan to email along some other thoughts on the book, if you are interested.

  3. Professor, do you have any place where you aggregated common objections and criticism of FTPL with answers? I'm pretty sure I've seen something like this in a blog post here, but I can't seem to find it. It might be buried in another topic (or maybe the search engine isn't that good here). And I glanced over the table of content of the book and I'm not seeing anything that obviously screams "here are the objections people raised as the theory developed and here's what's wrong with those objections."

    If it doesn't exist yet, it would be useful to make it. I'm trying to wrap my head around some of those ideas and it's useful to have the response from someone who (1) understands the theory deeply and (2) actually means it when reading someone who issues those criticism. That way you get the best version of both arguments and things get clearer.

    1. Chapter 23 "disputes" has some, and much is woven in to the text, on active vs. passive regimes and on s-shaped surplus process. "Money as stock" is a response to the critiques of the era. The point of the book though is that FTPL stands or falls on its usefulness not on equilibrium-selection theoretical controversies. As did MV=PY and ISLM.

    2. And I missed it by glancing too quickly over sections in the table of content! Thanks.

      I noticed that the theoretical controversies were oddly technical. They have the flavor of those weird politically motivated nonsense debates you find online. Theory tries to find a small set of restrictions to capture a large set of phenomena, so the critique that sticks will put its finger on a tension, claim that a model essentially forces you to play a game of force fitting the wrong cover on the wrong container where if you press right, it pops out left and vice-versa...

      But, even if that's not what they're doing, I try to avoid being too dismissive in case I missed something.

  4. Finn E. Kydland (Norwegian School of Economics and Business Administration), and Edward C. Prescott (Carnegie-Mellon Univ.) wrote an article, "Rules Rather than Discretion: The Inconsistency of Optimal Plans", J. Pol. Econ., 1977, v. 85, n. 3, which impressed the Nobel Prize in Economics committee to the point where Kydland and Prescott shared that prize, according to the obituary of Finn Kydland in today's The Wall Street Journal (Nov. 9/22). The article is accessible online by conducting a search with the article's title as the search term.

    The authors write, in the conclusion of the worked example in the article, "There are two lessons we learned from the examples. First, the use of optimal control theory is hazardous and could well increase economic fluctuations or even make a stable economy unstable. Second, even when it does work reasonably well, it can be improved upon by following some other simple feedback rule." The worked example is of an investment tax policy optimizing a quadratic social cost function under linear constraints, in an infinite horizon economic model with a constant returns to scale Cobb-Douglas production function.

    In s. VI, Discussion, the authors remark, "The analysis also has implications for constitutional law. A majority group, say, the workers, who control the policy might rationally choose to have a constitution which limits their power, say, to expropriate the wealth of the capitalist class. Those with lower discount rates will same more if they know their wealth will not be expropriated in the future, thereby increasing the marginal product and therefore wage and lowering the rental price of capital, at least for most reasonable technological structures.

    "Still another area is the current energy situtation. We suspect that rational agents are not making investments in new sources of oil in the anticipation that price controls will be instituted in the future. Currently there are those who propose to tax away "excessive" profits of the oil companies with the correct argument that this will not affect past decisions. But rational agents anticipate that such expropriations may be made in the future, and this expectation affects their current investment decisions, thereby reducing future supplies."

    The article was published in 1977. The authors' observations remain pertinent in 2022, vis-a-vis, the current administration's energy policies and taxing policies.

    1. Erata: The obituary in The Wall Street Journal was for Edward C. Prescott, not Finn E. Kydland. I failed to check the source before penning the remarks above.

    2. Errata: In the 3rd para., 3rd sentence, the word "same" should read "save".

  5. The problems with Fiscal Theory aren't even comparable in scale to the problems with the Taylor rule (as used in standard models to induce unbounded dynamics in the linearized model).

    Have a professional economist try explain to Greg how the Taylor rule works and I guarantee he will think Fiscal Theory is better. I say "try" to explain because it's so nonsensical no one can actually explain it and hence no one knows how it supposedly works.

    Or maybe I'm wrong and companies can raise their stock prices by threatening to aggressively split their shares. Who knows.


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