John Cochrane, economist at the Hoover Institution, has written a very interesting, very short piece, for the Wall Street Journal that discusses some crucial elements pertaining to inflation and the efforts to keep inflation under control.
In this discussion, Mr. Cochrane advances three important considerations that should cause investors to alter their understanding of inflation and the roles that monetary policy and fiscal policy play in generating or controlling future levels of price level changes.
First, Mr. Cochrane considers the policy situation in the 2010s.
Early on in the economic recovery following the Great Recession, which ended in June of 2009, the Federal Reserve began to pump up the money stock.
Many analysts, myself included, began to raise concerns that the rising money stock was going to cause consumer price inflation to increase, and, given the rate at which the money stock was increasing, the expectations for future inflation were pretty scary.
But, for the decade, consumer price inflation was rather tame. Between recessions, the Federal Reserve’s target consumer price index rose at a compound annual rate of about 2.2 percent.
Very acceptable.
It was also true that economic growth during the same time was relatively modest and this was not liked by the government’s policy makers. But, this was also a part of the result that gave the government policymakers a low rate of inflation for the period.
Mr. Cochrane concludes: “QE (quantitative easing) had basically no effect on inflation.”
Inflation did not rise because the government’s fiscal policy did not create the spending pressure needed at the time to cause an excess demand for goods and services.
“In the fiscal view, overall government debt, including reserves, matters, not its particular maturity.”
And, “overall government debt” increases were under control.
Thus, the government stimulus went into financial assets and not into real assets, which would have resulted in higher inflation.
This is another way of describing what happened in the 2010s, very similar to the one that I have been presenting over the past 10 years or so in this blog. I have referred to the government policy approach as one of “credit inflation.” I have traced the monetary and fiscal efforts of the time through the financial circuit of the economy and not the real circuit of the economy.
Mr Cochrane also dismisses the use of the Phillips curve, much as I have in my writings. My approach is presented in my post “The Phillips Curve; Doesn’t Exist.
Mr. Cochrane writes this: “The Phillips curve remains the predominant mode of thinking about inflation, but his view has utterly failed.”
So, we do not have to increase unemployment in the economy just in order to reduce the amount of inflation that exists in the economy.
Mr. Cochrane adds that “witch hunts” for “greed,” “price gouging” and “monopoly” have followed inflation for centuries.
Conclusion: “They too at best confuse relative prices for the level of all prices and wages.”
Third, Mr. Cochrane looks into the future and pays very little attention to the efforts of the Federal Reserve to cut back inflation and the inflation of the future.
My recent review of what the Federal Reserve is doing leads to very similar conclusions. The Federal Reserve, in recent years, has bought over $5.0 trillion in government securities.
In its current effort at quantitative tightening, the Fed, after 16 months, has removed only slightly more than $900.0 billion in securities from its portfolio. At the same time, the Fed has loaned out more than $200.0 billion to the banking system through its borrowing window. This is peanuts in terms of the amount of debt that the federal government will be issuing in coming years.
Mr. Cochrane again:
“The U.S. is running a scandalous $1.5 trillion deficit with unemployment at 3.6 percent and no temporary crisis justifying such huge borrowing. Unfunded entitlements loom over any plan for sustainable government finances. The Congressional Budget Office projects constantly growing deficits, and even its warnings assume nothing bad happens to drive another bout of borrowing.”
Another “bout” of inflation in the future?
No matter what the Federal Reserve does, will there be another “bout” of inflation for the future?
Mr. Cochrane has been trying to develop another, “new,” narrative to explain what has been happening over the past decade.
I have also been trying to develop another, “new,” narrative to explain what has been happening.
Although Mr. Cochrane and I are looking at the picture from slightly different positions, I firmly believe that both of our approaches are coming up with the same stories.
It is very important for investors to view this territory as well and come to their own conclusions.
The investment community had to change its viewpoint when the Federal Reserve began its program of quantitative easing following the Great Recession and the very rapid increases in monetary growth did not create the inflation that the fast monetary growth seemed to project.
The investment community has had to experience the problems connected with the spread of the Covid-19 pandemic, the following recession, and the Federal Reserve asset bubble resulting from its massive injection of funds to fight the financial and economic turmoil of the early 2020s.
Now, the job is for the investment community is to build a narrative from which to operate over the next few years.
The material presented above is a good place to start.
I will be continuing my approach into the future, gathering support for that approach from people like John Cochrane and others of at least similar quality.
Read the full article here
