Wednesday, November 2, 2022

We're all supply siders now -- Summers and Poilievre

Larry Summers wrote an interesting oped at the Washington Post. Mostly, he still is of the adaptive-expectations ISLM view that interest rates must exceed current inflation before inflation will decline. (The issue here (blogpost) and here (paper).) But listen to this:

Questions of macroeconomic policy are not about values but judgments about the ultimate effects of various actions. As Fed chair during the early 1980s, Paul Volcker famously tamed out-of-control inflation at the cost of a severe recession. But he did so not because he cared less about unemployment or worker incomes than his predecessors did but because he rightly recognized that delay in containing inflation would only mean more pain down the road.

Would we all recognize common goals, but differences on cause and effect to get there.  

That’s why it’s vital that the Federal Reserve not waver. Chair Jerome H. Powell has vowed to impose sufficiently restrictive monetary policy to return inflation to within range of the Fed’s 2 percent target. The more confident that workers, businesses and markets are that the Fed will follow through on that, the less painful the process will be.

Within the conventional monetary policy community, praise for Volcker and the view, basically, that the Fed should focus on inflation and the labor market will take care of itself is sensible, but remarkably Reaganish. 

The tidbit that I found most interesting

Finally, the crisis of inflation should not be wasted. A bright spot in the dismal inflation period of the 1970s was the collaboration of Stephen G. Breyer (then counsel to the Senate Judiciary Committee), Sen. Edward M. Kennedy (D-Mass.) and the Carter administration on airline deregulation. In this era, high inflation should be a spur to regulatory changes — from addressing Jones Act increases in shipping costs, to strategic tariffs, to rules that force oil and gas to be transported via truck rather than pipeline, to punitive zoning restrictions — that will both reduce prices and make the economy work better.

As you know I've been preaching that "supply side" growth is the central problem and also the key to reducing inflation. Larry hasn't quite gotten to the latter, but this is the economist most identified with "secular stagnation," "hysteresis" and the view that all we need to do is borrow or print more money and hand it out to create growth. Now deregulation and the supply side is the key to growth. 

Larry is starting to sound like a Reagan Republican!  I'm sure he would say circumstances have changed -- that was ZLB (zero lower bound on interest rates), this is inflation. That's a consistent view. But inflation should wake us all up as it has Larry: All the old verities are over, there is only supply now, and that comes mostly from getting out of the way, as Larry recommends, not new "investments" of more borrowed money thrown down ratholes. 


Pierre Poilievre, the leader of Canada's Conservative party, wrote a great Oped in the National Post. Now that Liz Truss has imploded, perhaps Poilievre will become the international hope for a successful free market libertarian politician. 

Finance Minister Chrystia Freeland wants us to believe she has had an epiphany. After years of ignoring my warnings that Liberal deficit spending would cause inflation to balloon, followed by interest rates, she now claims to agree with me in a leaked letter to fellow ministers. Even her boss, Prime Minister Justin Trudeau, is uttering words unthinkable to him not long ago: “fiscal responsibility.”

The cost of government is driving up the cost of living. A half-trillion dollars of inflationary deficits have sent more dollars chasing fewer goods, which always leads to higher prices. 

We're all FTPLers (fiscal theory of the price level) now, some sooner than others. A clear explanation of how central banks create money and buy treasury debt follows. Then

 the Bank of Canada must pay interest — at the going rate. Because rates are now rising, the central bank is now losing money and will need a bailout from the federal government for the first time in history — something I predicted would happen two years ago. 

Fiscal constraints on monetary policy. Nice. 

Liberals like to say that all this inflation is the result of the Russian invasion of Ukraine. But less than 0.3 per cent of Canada’s trade is with those two countries, and the things that they produce are things we already have — food and energy. In fact, the higher commodity prices should have helped our resource-heavy economy, but for the fact that the Trudeau government has hit farmers with fertilizer tariffs and carbon taxes and blocked or bungled every single pipeline or LNG export terminal proposed in seven years.

Beside my thread, but an important point. His bottom line 

Instead of creating more cash, we need our economy to produce more of what cash buys: more food, energy and homes. That means removing gatekeepers that have made Canada the second slowest country in all the OECD to get a building permit. As prime minister I would challenge all three levels of government to work together to offer the fastest building permits in the OECD. This would mean going from 250 days to 28 days to beat the now first-placed South Korea....We would remove taxes and tariffs on farmers’ fuel and fertilizer....Finally, we would reform our taxes to reward work, savings, and investment so our workers and businesses can produce more of the goods we need. 

Simply put, we would stop creating cash and start creating more of what cash buys: food, homes, energy, manufactured goods and more. That is the only path to bigger buying power for paycheques and savings.

FTPL and deregulation-focused supply side growth. Well, us free market libertarians are like Chicago Cubs fans, there's always hope!


  1. Unfortunately, when the public hears talk of supply side economics they think of only one thing: it means lowering taxes for the rich. Getting beyond that to implement much needed microeconomic policy reforms has to overcome that hurdle as tax and spend politicians will pile on telling the public it is just Republicans again looking to cut taxes for the wealthy.

    1. Yes! The word "supply side" has now depreciated, and to most people it means, as you say, tax cuts (and to redistributionists "for the rich") and "trickle down". This perverts the whole idea. Keynesians are about sending people money, supply side is about incentives. Tax rate cuts, to improve incentives. But words are words and this one is no longer useful. I'm starting to use "incentive economics" to accurately describe the approach.

    2. Glad to see you have come around to my position.

    3. If you want less of something, tax it and the price will increase. We've seen this play out in the import tariffs levied by the Trump administration that have been continued by the Biden administration.

      Supply-side incentives work best when the incentives work broadly, not narrowly. If that requires lowering marginal tax rates on capital, then that is one broad measure.

      The FOMC Chairman, J. Powell, believes that by raising the cost of capital to "fight inflation", he will be successful in reducing the rate of inflation at some undefined future period. He's playing coy about what the Fed Funds rate must rise to in order to turn inflation off. Let's simplify his problem. To reduce the rate of inflation, the FOMC must trip the economy into a hard recession. To achieve that, the Fed Funds rate must exceed the 10-yr Treasury yield by 2-points, say, to 6.5%. This will yield a bank prime rate of 9.5%. Not quite Paul Volcker level of interest rates, but sufficient to cause a severe recession, given the rate of indebtedness in the economy today.

      The converse strategy is to pull out the stops that restrict supply from responding to the price signals being sent. Lift the import tariffs that currently restrict supply of semi-finished inputs, and put a halt to the restrictions on pipeline construction restricting the movement of energy between producer states and consumer states to lower energy prices. There a myriad of such regulations and restrictions. California is pre-eminent in that regard with its Air Resources Board. If you want less of a thing, e.g., affordable living, tax it and regulate into oblivion, California's way (also the way of the states of Washington and Oregon.)

    4. Yes, all life is about incentives and disincentives as well as trade-offs and constraints. regards, Steve

  2. I look forward to the federal government of Canada bailing out the Bank of Canada.

  3. This is tangential to the FTPL/supply argument, but it is something that has been bothering me for a while. Poiliveire says "...the Bank of Canada must pay interest — at the going rate. Because rates are now rising, the central bank is now losing money..." The same is said about the Fed - namely that, because the (notional dollar) yield on its assets is less than the amount it "must" pay on reserves, it will run losses for some time, booking a deferred loss until such time as it generates sufficient profits to restart its transfers to the Treasury. Given that it was only recently (I'm old) that the Fed began paying interest on reserves, what is really keeping them from once again paying nothing? Operating loss problem solved!

    1. They would lose control of the money market rates.

      Pre 2008 the Fed had a small balance sheet and conducted monetary policy by making relatively small changes to the amount of assets it held- which correspondingly changed the amount of reserves banks held to meet their reserve requirements. Now the Fed has bought lots of bonds, and banks correspondingly hold lots of reserves (so the reserve requirement is no longer binding). If the Fed chose not to pay IOR, then markets would push down interest rates on alternatives such as t-bills. This would neutralize the Feds ability to tighten monetary policy to slow inflation. I guess the Fed could raise reserve requirements significantly and pay 0% on the reserves, but that would just shift the cost to banks.

      The main problem the Fed faces is that it bought too many bonds at too high of a price and there is no free lunch

  4. "Instead of creating more cash, we need our economy to produce more of what cash buys: more food, energy and homes. " Great line IMO.

    For those of us without economics degrees, it would be handy to have acronyms spelled out. That would make the articles even more accessible for those of us trying to understand. I have no clue what is FTPL or ZLB and often when I "google" such terms I'm still at a dead end. Spelling them out would be helpful.

  5. As a Canadian who went to UChicago, I’m incredibly optimistic about politics here for the first time in a long while. Poilievre is remarkably well educated when it comes to the Glaesers and the Friedmans and Sowells of the world. There is a smear campaign in this country to label him as some half literate right wing extremist. Hopefully my country comes to its senses in the 2025 elections.

  6. I'm a new graduate student and I'm trying to wrap my head around this concept of FTPLers . I looked it up and it says that prices adjust so that the real value of government debt equals present value of taxes less spending. So is this saying that when inflation occurs it's because government debt value is high ? Could someone please clarify the relationship between the two?

    Now I realize that this may be an obvious concept to the economists but I would appreciate a response. I'm only a recent graduate from my undergrad so please go essy on me :)

    1. As you said, when government debt is higher than what people think the government can or will repay. It sounds like "looked it up" means Wikipedia. Wouldn't it be nice if someone wrote a book and maintained a webpage all about FTPL? You're in luck!


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