John Cochrane on Monetary Versus Fiscal Policy

monetary policy government debt inflation federal reserve price stability

June 9, 2023

John Cochrane is a renowned economist and senior fellow at the Hoover Institution at Stanford University. He writes a popular blog called The Grumpy Economist. He is also a former professor of economics and finance at the University of Chicago. He is the author of a recent book called The Fiscal Theory of the Price Level.

Today we talk about the monetary and fiscal theories of the price level, or inflation, discussing what inflation is, how it’s caused, and how to fix it.

Want to explore more?
Get an introduction to Monetary Policy and Fiscal Policy in the Concise Encyclopedia of Economics.
Arnold Kling and John Cochrane on A Monetary and Fiscal History of the United States, a From the Shelf conversation at Econlib.
Thomas Hoenig on Inflation and the Federal Reserve, a Great Antidote podcast Deep Dive.
Trey Malone and Jayson L. Lusk, No Yolk: Shortages and Spikes in the Time of COVID, at Econlib.

Read the transcript.

Juliette Sellgren 
Science is the great antidote to the poison of enthusiasm and superstition. Hi, I'm Juliette Sellgren and this is my podcast, the Great Antidote named for Adam Smith, brought to you by Liberty Fund. To learn more, visit www Adam Smith

Welcome back. Today on May 23rd, 2023, we're going to be talking about theories of the causes of and solutions to inflation or potential ones. I'm delighted to have John Cochrane on the podcast. He's a renowned economist and a senior fellow at the Hoover Institution at Stanford. He is a 2023 winner of the Bradley Prize. They just released their speeches online, so you should go check his out. It's great. And he writes a popular blog called The Grumpy Economist. He's also a former professor of economics and finance at the University of Chicago, where he was the editor of the JPE, the Journal of Political Economy. I feel like in my head I say it as an acronym and then I've never pronounced it out loud. So he's also the author of a recent book called The Fiscal Theory of the Price Level. So thank you for all the work that you've done and thank you for joining me on the podcast.

John Cochrane 
Thanks. It's a great pleasure to be here.

Juliette Sellgren 
So before we get started, what is the most important thing that people my age or my generation should know that we don't?

John Cochrane 
Can I give you two?

Juliette Sellgren 

John Cochrane (1.41)
As your listeners assume about to find out. I'm not very good at short answers to any questions. I'm tempted to give the obvious political one. Most people when they're young and especially these days, don't have appreciation of the history, the institutions, the wonderful and delicate society that we live in and where it came from and your role in preserving those institutions and how much better we are off than our ancestors and we want to make sure our children are the same way, but I'll give you a personal one instead, or that's my way of hiding too into one answer. I look back to when I was your age at least, and I lived in a fog, so I'm going to give you the old man's advice. Life is really short. It's shorter than most young people think it is, and it's more random. So you just bat around from thing to thing.

I called myself in the major of the month club for a long time. I've done all sorts of things and you never really make a plan. You just try lots of things and stick with the ones that work, but you got to also think about how fast life will go by. I still feel like I'm 19, but I am 65 and it seems like it went by in a blank of an eyelash, and most young people don't think forwards. You don't really understand what life is life, but you can. I think it's unfortunate because we don't really live in village lives anymore. You used to have aunts and uncles and lots of people at all stages in life that you could sort of identify with, and now we kind of live alone when we're young, so life will come. Don't waste your twenties goofing around your twenties is when you build experiences that turn into careers. Nobody knows what they're going to do, but just do things. I'll give some personal advice too. When you're dating, you're looking for the person that you can raise kids with, marry young, have your kids the young, stay married, max out your 401k in stocks, and think ahead.

Juliette Sellgren 
That's funny. I was just thinking to myself earlier today, you are freaking out about the future for no reason. Life is not that short. I guess maybe I'm wrong, but I don't know. It's kind of interesting because with so many kids, especially my age with anxiety, it's almost like all they can think about is the future and yet we don't really think about the future at the same time. I don't really know how to make that make sense because I guess I'm not a doctor part of it.

John Cochrane (4.27)
No, I think you're onto something. There is this, well-documented anxiety and mental health crisis, which is kind of strange. The United States is right now the most prosperous, healthy society that has ever been. And it's funny, lots of people don't think about exactly when am I going to have kids and how? But they do think about, oh, the climate is about to, the oceans are about to boil. I think as Al Gore put it and sort of live in this vague anxiety about very low probability events, but don't think about their own lives very clearly.

Juliette Sellgren 
I think part of it is also almost like a focus thing. Instead of stressing out about the things that you can't really control or even if you can, it's super duper marginal. It's even more marginal than arguably anything that we talk about with regard to marginal evaluation and your life is in your hands, so maybe that is easier to be in control of. I don't know. That's just my current thought. 

John Cochrane (5.33)
Well, don't get too swept up into political causes is a good piece of advice as well as worry about things that you can control. That's a good piece of advice. Anyway, that's my fatherly advice for the beginning of the show.

Juliette Sellgren (5.48)
It's much appreciated. And now let's turn to inflation, a less fatherly topic. Maybe we're facing inflation seemingly for the first time in a little bit, I feel like. Well, I mean it's always happening 2% or something, but as bad as that is, it's kind of lucky for you because you just put a book out on a new way to think about inflation called the fiscal theory of the price level. And lucky for you, I say not because you don't face inflation the way the rest of us do, but because economists have thought about inflation in one way for a while and they thought that they had conquered it, but that's not really the case and we're going to get into that. But what started the inflation that we're seeing now, and I guess what is not necessarily the right question? There are so many theories about what exactly, but when I guess,

John Cochrane (6.51)
Yeah, you mentioned luck and I will say I am incredibly lucky. I was thinking about inflation since about 1980. I was around for the last time we had inflation, finally got a book on inflation submitted to the publisher in March, 2021. The introduction said, well, we haven't seen inflation since 1989. It's going to care about this book, but someday dusted off the shelf, maybe it'll be useful. And then thanks to various policy missteps, they got exactly what I told them not to do and hopefully I'll sell some more books. So maybe, yeah, my salary doesn't keep up with inflation just like everyone else's, but I hope my book sales will.

So where does inflation come from? I think I was also lucky in that of course all economists say this is exactly what I predicted all along, but I feel that way too. I guess in my view. So my book is the fiscal theory, the price level, which we'll get into a little bit. But during the pandemic, our government basically printed up $3 trillion of new money and wrote people checks and they borrowed another $2 trillion of money and wrote people more checks with no talk at all about how are we going to pay all this back? Just out of nowhere. They sent people checks, people ran out to spend the money, and guess what? Inflation comes. So I think it's no mystery at all why we had this bout of inflation. There you go.

Juliette Sellgren 
And so what is inflation?

John Cochrane (8.26)
That's a good thing I think. Thank you for asking that because a lot of the alternative theories and so forth come down to misunderstanding the phenomenon. Inflation is when the price of all things goes up, and although it's not in the measure, I would include wages as well. So the common mistake is to say, oh, apple prices are going up. Inflation. Well, if apples are going up relative to bananas, that's a relative price change. And so a lot of this came in there were supply shocks. We can't get enough TVs through the ports. So yeah, the price of TVs has to go up relative to wages. We can't afford as many TVs or it has to go up relative to the price of fruit or something sort, but that's a relative price change. The part that's really inflation is the part of all things going up, prices and wages going up together, and that really only can come from, let's call it too much demand, though I hate that word. It's a decline in the value of the currency and a decline in the value of the government's debts. That's the common component to everything that's inflation. What's confusing. Of course these happen at the same time and that's part of the damage of inflation. Inflation always comes when lots of relative prices are changing and TVs are going up faster than restaurant meals and stuff like that. So that's the smokescreen in front of the fundamental phenomenon.

Juliette Sellgren 
So how is it measured? You mentioned that wages aren't included.

John Cochrane (10.07)
Yeah, so imperfectly, yeah, Bureau of Labor Statistics goes out and tries to put together a basket of all the goods and services that people buy, and they're very detailed. They have people that go out and say, one 16 ounce can of Campbell's tomato soup at this store. What did it cost this month and what did it cost last month? And they try to put that all together to figure out what a basket with a basket of goods and services that people buy costs. Now you can imagine how hard that is because two things. First, there's a lot of things like healthcare and who knows, knows where the funny money comes from and things like the value of your housing. What's the value of the housing services you have? How do you value the government is now close to half of GDP? How do you put a price on all that stuff and how do you handle new?

The new iPhone comes in and it costs 10% more than the old iPhone. Well is that inflation or is that actually deflation because 20% better. So it is imperfectly measured, which is, I think it's kind of funny when people get all upset about 2.1% versus 2.0%. It's measured at best within a percentage point anyway and especially over long periods of time. So exactly how much better or worse off are we than we were in the 1970s? Well, you could have three Ford Pintos or you could have one Tesla. Is that really the same thing? Very hard to measure, but it is the best measure we got and it's pretty good, at least for short run things, and when it's 10% versus 2%, something very serious is happening

Juliette Sellgren 
And about 10% is what we have right now.

John Cochrane (12.06)
I did not look up the latest numbers before coming on the show, but a good resource for, I'll point you to the source, go to FRED. Fred and the St. Louis Federal Reserve has a wonderful website where you can get all the government data you want, but yeah, it is down from 10%. My memory is dependent as core inflation and headline inflation and personal different measures, but we're now I think in the roughly 5% range.

Juliette Sellgren (12.30)
So I guess 2021 covid, all of that. People- including economists- and also people at the Fed seemed kind of confused about the difference between inflation and the changes in relative prices. The thing you were just talking about, the price of apples versus every single price, how does this idea of transitory inflation play into that? How did it come out of this and is it a new idea? Is it a super valid idea?

John Cochrane (13.07)
Yeah, it meant more than the, I mean the English word transitory means it comes and goes, and in that sense, all inflation is transitory. The great German hyperinflation, well, it came and then it went, but I think that they had something more in mind, which is one of the difficulties of measuring inflation and understanding it is that you often will see little spikes in measured inflation that go away. If oil prices go up one month, they're likely to come back down again. So you'll see a little blip in measured inflation, but that's not something that's going to last. I think that's the kind of thing that people had in mind when they talked about transitory. There was a lot of economic upset in the pandemic, so a lot, the real meaning I think they had in mind with the transitory stuff was you can't get TVs through the port, so the price of TVs are going to skyrocket this month, but that price level will be back again.

So not just will the inflation go away, but the inflation will reverse itself to deflation and will be back to the prices where they were originally. That was absolutely wrong, but it's very difficult in real time. The Fed has a hard problem. Is this just a couple prices, like a shortage of oil that goes up and then comes back down again? Or is this something that's going to spread and become a part of everything? Is it fundamentally supply versus demand? Now here there's also lots of conceptual errors and conceptual difficulties that went under it. One is we've already mentioned not understanding relative prices versus the price level. Already in the pandemic you could see, yeah, the price of TVs was going, but so was the price of everything else, and so were wages. There was a labor shortage, so you could see it was pretty widespread already.

And inflation since Emperor Ian's inflation in the sixth century has always brought out all sorts of economic bogeymen and horror stories. It's the middlemen, it's the speculators, it's the great, I remember, I think it was Elizabeth Warren went after the great chicken monopoly that was raising prices, so it's greed and where was this greed before? I don't know. But all of a sudden producers got greedy and raised prices, and this one makes inflation for me so much fun to study. It's not obvious. It's one of those lots of economics is kind of obvious. The price of apples goes up. Well, either there's a sudden craze that people want to buy apples or there was a frost in the apple harvest and it either supply went down or demand went up pretty understanding you could go out and figure it out. You go out and try to be a journalist with inflation, it's really hard.

You go to the price of bread went up. So you ask the grocery store, why'd the price of bread go up? And grocery store says, oh, the wholesaler raised the prices, and you go to the wholesaler and wholesaler says, well, the bakery raised the prices, and the bakery says, well, wheat's going up and water's going up and electricity's going up, so we got to pass that along. You go to the farmer and the farmer says, well, seeds are going up and wage is going up. You go round and round in circles and you never get anywhere. It's hard to find out that the government printed up too much money and sent people checks.

Juliette Sellgren (16.21)
Yeah, I mean this kind of makes me think about how when Europe was really affected at the beginning, and I mean probably still now a bit by the war in Ukraine with the restraints on oil and gas and stuff like that, it looked like there was inflation because everything was going up. But at the same time, everything changes because of food and energy and the influence they have on everything. And so I mean, I guess, I don't know if you know what that was, if it's inflation or if that was just relative due to those prices, but it does seem like a really complicated and compelling area to try to figure out.

John Cochrane (17.07)
It is now, energy prices were all headed up well before the war in Ukraine, and in fact, Russia was happily selling energy to anybody who wanted it. The actual supply of energy did not decline with the war in Ukraine. So I rate that as largely an excuse and politicians don't want to say we overdid it with the pandemic stimulus. We're overdoing it with our deficits. It's so much nicer to say, oh, it's all Vladimir Putin's fault. So there's a lot of excuse making going on, but I think Europe too now is fairly clear. They too handed out enormous amounts of money, not quite as much as we did during the pandemic, and then of course they reacted to higher energy prices and decreased supplies from Russia by printing up money and giving people more money to buy the energy. Well, that's not going to help the inflation a lot.

Juliette Sellgren 
Yeah, it's interesting. I was in France a few months ago and they had the lights off everywhere, which I didn't think was necessarily a bad thing. It was just a weird site when the Eiffel Tower was turned off and I was like, huh.

John Cochrane (18.17)
Well there is a wonderful story going on in Europe and I really want to cite my colleague Ben Ma at the London School of Economics who was, he's German and he was really, when the war started, there was lots of outcry about how the economy's going to crater because we won't have any oil and so forth. And the magic, there's a lot of economic, one of the magic things in economics is substitution the ability of people to, you look at oil and you say, oh, making something takes three barrels of oil. If we only got two barrels of oil output will go down by two thirds. Well, it turns out that especially in the short run, you can rearrange things well and especially both short and long run. You can rearrange things to make do with a whole lot less oil. And the German economy has come through and the French economy much, much better than all of the politicians thought it would because of the magic substitution and some of it's not fun. Now, one of the things Ben pointed out, for example, a fertilizer takes a lot of natural gas to produce. So what can you do about that? Well, one thing you can do is shut down the domestic fertilizer that keeps the economy going. It's not necessarily great for Europe of course, because then now they've got to export stuff instead. But you certainly don't have to not have fertilizer in the crops this spring because we have less oil

Juliette Sellgren (19.42)
Thinking about inflation or just generally makes me think of all these questions that I've never really understood. Kind of going back to the us, so the Fed defines price stability as a two percentage growth in the price level. Why is it not zero?

John Cochrane (20.03)
Good question. The Fed's mandate is price stability. How did we get from price stability to eternal 2% inflation? I'd like to know, I read the clear words of the mandate as price stability, meaning price level is the same and that's not just 0% inflation. If there's a unexpected one or 2% inflation, we got to squeeze that out and get prices back to where they are. And indeed, when that was written price stability, we were still into the gold standard, which had kept the price level stable for hundreds of years. Now it wasn't great. I'm not advocating back to the gold standard, just it's clear to me the intent of that was the price level should be stable. And so I'm actually, I think that's an not just, I don't want to be legalistic. Let's be an economist. I don't see why we need 2% inflation forever.

The excuse for it is, it's sort of like the old idea that wearing shoes that are two sizes too small during the day, it feels so much better to take them off at night that if you have a 2% inflation regularly, then interest rates can be three or 4% and then the Fed can lower interest rates more to stimulate during a recession. I won't go too deep into economics. I don't think that really makes much sense anyway, so I don't see why we have to have constant 2% inflation. So right back to zero. I'm with you.

Juliette Sellgren 
Yeah, the shoes thing makes it seem really uncomfortable. Okay, so the prevailing theory for all these years was about the cause of inflation was that monetary expansion was a cause of printing the money? I think so. Can you explain how this theory works, what it says?

John Cochrane (21.49)
Yeah, and I'll explain it by contrast with my favorite- the fiscal theory. So we both agree if you print $5 trillion and hand it to people in the form of checks that they're going to go out and spend that and there isn't enough to go around, we're getting inflation perfectly sensible. So it's too much money chasing too few goods and services. That's always inflation. The question is what exactly is money and how much is too much? Now the monetarist, which is exactly what you're referring to, took that observation and most of the historical episodes are in fact governments printing money to cover deficits and causing inflation. But when you say it's too much money, that is too much money relative to other things. So the standard view was money is not a great thing to hold because it doesn't pay interest, but you need some money in your wallet in order to make your transactions.

So it was just the special stuff that you hold to make transactions that counts as the money that causes inflation and in particular, so the prediction there is, yeah, we all agree print out 5 trillion bucks, hand it to people, you'll get inflation. But suppose you print up 5 trillion bucks and hand it to people, but at the same time you take back $5 trillion worth of treasury bonds, so you're no wealthier overall. You just have too much money and not enough treasury bonds. Will that make people go out and spend? Well, here's where we divert. The classic theory says yes, it's only about the amount of thing in the special form called money that matters. It's not about you're having more overall wealth than you thought. It's about having too much money and too few bonds. Whether or not we take away the bonds and cut your wealth by $5 trillion makes difference at all.

It's just as inflationary. Whereas my view, the fiscal theory view says money and government debts are all kind of like the same thing. And so if we print up 5 trillion bucks on money but take back 5 trillion bucks of treasuries, then you wouldn't have the inflation. If imagine if in the pandemic that there had been no deficit whatsoever, we simply rearranged things and instead of people holding treasury bills directly, people held money market accounts that had treasury bills that make any, I say that wouldn't make any difference. Standard monitors say it makes a huge difference. So that's really the cleavage point between the standard monetary view and the fiscal theory view. Is it money versus bonds? Is it something wrong with the composition of the assets you hold or is it overall too much government debt of all forms, including money relative to what you think they're going to pay it back?

Juliette Sellgren 
So then where does your skepticism come from for the monetary theory and I guess how does the fiscal theory fix or appease those worries maybe?

John Cochrane (24.55)
So my skepticism, it's fun, it's long and deep rooted. I picked it up from my thesis advisor, George Akerlof at Berkeley. I went to Berkeley, a convinced Maoist, and George really picked it apart from a bunch of ways. One, we tell a story. If you've taken an economics class, you probably got told the story of you have to go down to the bank and cash in your bank account to get money to go spend. And anyone your age must look at that and say, cash, a check and hold. What is cash anyway? I have this phone thing that I used to. Is that what you're talking about?

Juliette Sellgren 
You don't take Apple Pay Exactly. What do you mean?

John Cochrane (25.39)
It probably, it was a decent theory about 1935. So that doesn't really hold much anymore. That's an undermine the lack of the basic story about money versus saving as being very different things. And then the Fed right now does not control the money supply. So this story requires that the Fed controls the money supply. The Fed doesn't do that. The Fed targets interest rates. So you need a theory that recognizes that the Fed targets interest rates and all the classic monetary theory. Go read [Milton] Friedman's 1968 [AEA] presidential address1968 [AEA] presidential address. It's a masterpiece of economics. But one thing he said in there is the Fed can't target interest rates. If you do, things will blow up. Well, the Fed's been targeting interest rates since 1968 and things went a little awry in the 1970s, but you can't say that we have Zimbabwe in levels of inflation. So the evaporation of money as a separate asset, I'd say is influential to me. The fact that the Fed controls interest rates and we need a theory where the Fed can control interest rates and not money supply. That all drives me to fiscal data, the price level. Plus it's really beautiful. I must admit I'm attracted to beauty. It is more Chicago than Chicago, really. It's a very simple, clear theory of where inflation comes from.

Juliette Sellgren 
So I guess could you lay it out for us in simple beautiful term?

John Cochrane (27.09)
Oh, I've been waiting for this. What is the fiscal theory of the price? It says that inflation comes when there is more government debt that includes cash, but it also includes treasury bonds and bills more government debt. Then people think the government can or will repay eventually by charging taxes more than spending. Yes, that does happen. Governments do repay their debts. They don't just keep piling it on. Eventually they have to. Why is that the case? Because when we all look around and we see right now, I think most people bond markets. There's a lot of hot air coming out of Washington. But come on, this is serious country. This is the best country in the world really. We're going to have an Argentine style debt crisis. No, come on. Sooner or later they'll fix Social Security, Medicare. We'll go back to the sound sort of government finances that we've had for hundreds of years, but when people decide that's not going to happen that there will be a default or there will be in the future just printing up money to pay off debts that the government will not pay back its debts.

So what do you do about it? Well, you try to get rid of your money and your government debt. You try to buy stocks, bonds, real estate, foreign currencies, whatever you do. And as we try to get rid of that government debt, we push the prices of everything else up. So it's real simple, too much government debt relative to what people think the government will repay over the long run that causes inflation. Now, it's not so easy as debt and deficits cause inflation because our government can borrow enormous amounts of money if there's a credible plan to pay it off. We did that in World War II. There's a war, it's not going to last forever. We're going to borrow a ton of money and when the war's over, there's going to be taxes and spending cuts to pay it back. Yep, I'll give you my money on that Uncle Sam. But so you can have a lot of current deficits, but the tricky part is it's relative to do people expect it to be paid off and like vice versa, you could have no current debt deficits, but if people lose faith that Washington will eventually pay it off, then they run away from government bonds Today it has a lot of the flavor of a bank run.

We've had this faith, oh, sooner or later that government debt's always sacrosanct. They'll repay government debt. Well listen to Washington. They're loudly telling you we'd rather default on the debt than cut Social Security 1 cent. That kind of thing could undermine that. So anyway, fiscal data price level is overall too much money and the government debt, it's all kind of the same thing relative to what people think it will pay back in the long. It's very much like it comes from asset pricing. It works the same way as a stock price is the present value of the dividend payments. And when people say, huh, this company's not going to make any money, there won't be any dividends, what happens? The stock price goes down. Well, same when people say, ah, this government's not going to be able to repay its debts. What happens? The price level goes up.

Juliette Sellgren (30.15)
It's funny almost how much it has to do with expectations of consumers, of the people in the system. I remember in my intro macro class learning about Milton Friedman and how he was wagging his finger at all these economists being like, just you wait. This is not how people anticipate inflation and the development of different theories of how people project themselves and government spending into the future. I don't know. I feel like it makes a lot of sense. I was thinking about this earlier today when I was preparing for this. I watched this video of you where you were talking about how at the Fed they use all this jargon and you never really know what they're saying because they're kind of trying to cover it up maybe because otherwise it would be a little too obvious what they were doing. And it's almost as though they behave in parallel or in accord with this theory without knowing it. This is just the natural, I guess that's what economics is, is that you're trying to explain the thing that's happening and by kind of playing around with the words and making it harder to understand, you can't really expect what's going to happen as well. Does this make any sense?

John Cochrane (31.42)
You're onto a deep set of issues here. Let me respond to both on the expectations. So I wish you can understand this issue. The basic theory is pretty clear debt relative to expectations of what the government will pay off. Well, where did that come from? And I wish I could come up with a separate measurements. What's the expected future primary surpluses that repay debt? But that's very hard to do. And here it's, let me make an analogy though. It's very much like the theory of asset pressing. I'm sort of like a 2-year-old who got a hammer and everything looks like a nail and that hammer is price equals present value dividends. I learned that one finally. And fiscal theory is really just applying that same idea now. So I want to take you here because there I think we're more comfortable. Where does this expected dividends come from?

Well, we do the best we can and the theory does use rational expectations. That doesn't mean clairvoyant, it doesn't mean particularly good expectations or good forecast. It just means people do the best we can. And I think that the nebulousness of it all also helps to understand why it's so hard to forecast. The fed's pretty bad at forecasting inflation. Well, fed's also pretty bad at forecasting stock prices because really who knows what's going to happen? So we do not require clairvoyance here. I think where do people's expectations of the government's ability to repay come from? We're actually on more solid ground than we are with stocks. Where does expected dividends from Tesla in 10 years come from? I don't know. But if you're going to buy stocks, you got to think about that. But really for government debt, we have hundreds. I'll go back to my first thing about the wonder of the institutions.

We have a wonderful set of legal institutions designed to encourage the government to repay and not to inflate away its debt. So really it comes from faith in those institutions that and the norms of good behavior and the reputation of the treasury for repaying its debt and not inflating it away. And that's the sort of thing, look for that loss of faith if you want to look for where inflation comes from. Now what you said about the Fed is also very, so it works like stock prices in the same way. So what determines the stock price today? Well, there's the expected dividends next year, which is 2% of it, and then what the price is going to be next year. So that's why a favorite of people who are soon going to spend time in federal penitentiaries is to try and convince you the stock price will be higher next year and get you to buy it today.

Now of course, as you iterate that forward, well, where does the price next year come from? Well, the dividends and so forth. And that's as you unwind that you get to the view that, oh, fundamentally the price is due to the whole future dividends, not really next year's price inflation works the same way. So if we all know inflation's going to be higher next year, what do you do? Well, you run out and buy today, right? If I tell you that that new TV is going to cost 20% more next year, go buy it now. And if you're a store and the price is going to be 20% higher next year, raise the prices now. So expectations that future inflation in the short run have a lot of effect on inflation today, and the Fed kind of knows that. So that's a lot of the speeches are about trying to convince people that inflation will be low next year so that they won't raise their prices now. But you can tell like stocks, eventually the fundamentals win out. And all these beautiful speeches about anchored expectations have to be anchored by something and not just by more speeches. And that's where fundamentally you iterate the idea forward and you go, oh, in the end it's really driven by fiscal policy, by the government's ability to pay back its debt. But I think that accounts for a lot of the fed's. Speechifying is trying to manage expectations to make their life easier.

And that's where we get to the rational expectations really just says you can't fool people systematically. You can fool people a couple of times, but sooner or later they catch on and stop paying attention to politician speeches.

Juliette Sellgren (36.02)
So maybe what I'm hearing is if they were in the private sector that they would go to jail.

John Cochrane 
I didn't say that.

Juliette Sellgren 
Okay. Well, I said that a little bit.

John Cochrane (36.13)
They are talking in their book though, and that's one of the difficulties of the Fed and it's actually an honest difficulty. We had a Hoover conference a while ago, and Steve Davis had a brilliant little paper on this question. We were looking at how did the Fed miss 8% inflation? That's your prime thing is inflation and 8% inflation came and they're still mumbling around about transitory and they're forecasting it to go right back. Then again. How could they get anything wrong? There's a lot of conceptual mistakes, some involving they don't pay much attention to supply. But one of the problems is if they said, oh my God, we're forecasting 8% inflation next year, even if that's an honest forecast, of course the markets would go completely nuts. So distinguishing the forecast from the speech of what we'd like to be is very hard for the Fed.

Juliette Sellgren 
Yeah, it seems like a hard job.

John Cochrane (37.08)
Well, part of the hard job too is the Fed, to be honest, the Fed both doesn't really know how it works and doesn't have anywhere near as much control over inflation as it would like us to believe. And most people do believe. And that runs hard up against the institutional prerogative, the institutional necessity in Washington these days to look like you completely understand every detail of everything and you're totally in control. But the fact is, and this is also something that is clear in fiscal theory, the Fed has much less limited power to control inflation. And the mechanism by which higher interest rates may lower inflation is much more tenuous than all this technocratic gobbly gook would have you believe. The one thing I know from 40 years of studying this stuff is the limit. I know what everybody else doesn't know. I know there isn't some secret book out there, some secret article where in fact it's all spelled out and they really know how it works. No, sorry, Mr. And Mrs. America, the Fed is a lot less in control than you think, and they understand the mechanism a lot less than the fancy words would make you think.

Juliette Sellgren 
So there are different schools that have thoughts about how to stop inflation. So the monetary has to do with the interest rates. How does that differ from the fiscal approach to stopping inflation?

John Cochrane (38.36)
Yeah, this is a hard question and here having just given a speech about lack of knowledge, I'll give you my own, I think through models. So I can give you the answer with the best models I know how to write down, but I recognize the limits of those models and I'm still working on better models. But as best I understand the world right now, the Fed has a strong influence on inflation. It can raise in lower inflation long run, although in the long run it's hooked up the opposite way. What we know that over very long time periods, higher interest rates go with higher inflation. Venezuela has a hundred percent interest rates and a hundred percent inflation. It's not the other way around, but the Fed can control things over the very long run. But there's nothing, if the government runs up and spends 5 trillion bucks, throws out the window, there's going to be inflation and there's nothing the Fed can do about that.

The Fed can kind of control when it happens, but it can't control that that fiscal policy is going to cause inflation and the Fed can smooth out the path, it can lower inflation now, but by accepting a little more inflation in the future. So it has a short run ability to move inflation around, but it's a little more limited in the long run. So that all goes by way of saying, well, let's look back at history with also the importance of fiscal things. In the back of our minds, all the successful ends of inflation have involved jointly monetary policy, fiscal policy, and microeconomic policy. As long as the government is printing up money to pay its bills, there's going to be inflation, and there's pretty much nothing the central bank can do about that no matter what it does with interest rates. So you got to get the fiscal policy under control.

The central bank can stave things off for a while. So Latin American countries often have this. Brazil will have an inflation. The central bank does a whole lot of stuff with interest rates, clamps, downs, a bit of recession, inflation recedes, but they haven't solved the problem that they're not paying their bills. And then inflation comes right back again. So you have to solve the monetary problem, the fiscal problem, monetary policy has to help with that. And the best way to solve the fiscal problem is to let the economy grow. Raising tax rates is like walking up a sand dune because every time you raise tax rates, you kill the real economy. So the best way to do it is to let the economy grow. And that's actually what happened in the 1980s. The US had, there was a famous monetary tightening, but there was also a Social Security reform, a deep form of fiscal policy. There was a deregulatory reform, the economy grew like crazy, and the government by the 1990s was raking in money. So all three worked together. So I really, if you want, I think here looking at the future is difficult, and I may be wrong, but I think we're at the point where trillion dollar deficits and an unreformed entitlements crisis looming is not something we can ignore and permanently get inflation down into the low stable range again.

Juliette Sellgren 
Do you have a nugget of optimism for us as we close?

John Cochrane (41.52)
Yes. Two. One is that I work on inflation because where I think I know the answers and I find it interesting, but of course the most important thing in economics is long run growth inflation recessions, they all kind of come and go. It's a pain in the butt. And serious inflation, which will be like a sovereign debt crisis in the US is a pretty awful thing. But long run growth is way more important. I just don't do that because everybody else who does it is so much smarter than I, and I don't really have anything to contribute to it. And I do have faith eventually. I mean, really it's the question of are American institutions going to go by the wayside or are they going to hold and be rebuilt? And one of the institutions is that ever since Alexander Hamilton, we repay our debts. We don't really let a horrible inflation, we don't let a debt crisis break out. So I think I hope we're away from that and that the simple kind of reforms that need to be done will be done and we can get back to it. But hold onto your pocketbook. If not,

Juliette Sellgren 
Thank you so much for taking the time to explain this all to me and my listeners and for sharing your wisdom. I have one last question for you.

John Cochrane (43.11)
I want to put in a last plug. The Fiscal Theory of the Price Level book has a lot of equations, and it's aimed at PhD economists, but if you go to my website, and find the fiscal theory tab, there's some essays in just plain English that explain these ideas without the equation. So I hate to be a guy on a book tour saying, don't buy my book, but go there and take a look. For example, at fiscal histories, which it talks about how do you use the fiscal theory to understand that's a good first dose of fiscal theory of the price level. Okay, go ahead. Last question.

Juliette Sellgren 
But if you're a mathematician or an economist, check out the book.

John Cochrane (43.48)
You have to learn to do fiscal theory at the price level if you're going to be an economist. And for that, you got to do the equations. Economics needs the equations. You just cannot. Beautiful prose will let you just get confused and not tie the ends up correctly. So things that are written in equations aren't necessarily right, but things that can't be written in equations are almost always wrong.

Juliette Sellgren 
That's a good point. One of my econ professors said that very thing, and I stopped criticizing the equations so much after that. 

John Cochrane 
The fact is, in economics, we don't have enough math. There's so many things that we talk about. Take those Federal Reserve speeches. Most of those just they're way ahead of the math that we have to make it precise. So don't make fun of math and economics. Okay.

Juliette Sellgren 
Alright. What is one thing that you believed at one time in your life that you later changed your position on and why?

John Cochrane (44.44)
Oh, gosh. Do I only get one?

Juliette Sellgren 
You can have two or three if you would like.

John Cochrane (44.52)
One of my greatest pleasures in my academic life is being proved that I'm wrong. And of course, in academic life, it happens over and over again, but it's a good reason to go in. There's nothing that I like better than something I've just believed without thinking too much about it. And then someone says to me, John, you're wrong about that and shows me exactly that I'm wrong and then changes my outlook on life. That just makes my day. And it happens pretty frequently in my professional career. I'll mention most of the things I do now. When I took my first, first macro class, I thought macro was all bs. It was horrible. And of course, here I am. I mentioned earlier, I started as a young monetarist until George Akerlof opened my eyes that had to be all wrong. I spent a lot of my life as a finance professor, and I distinctly remember taking my first finance class and thinking, this is all stupid.

They're just running regressions of one stock return on another stock return. How could you waste your time with that? Similarly, in macro, I had made fun of sticky prices forever, the whole New Keynesian literature until I learned about it. So there's a lesson there. Don't disparage things you don't know about as being silly until you learn about 'em. That's important. And similarly, my larger outlook on life and political orientation, that sort of thing has had many times when I just sort of unthinkingly went with what my crowd thought, and then somebody would slap me in the face and wake me up. And I'll say, one, I used to be just, I grew up in a university community. I was a standard issue liberal, and I bought the line that, oh, we need to get rid of, guns are terrible. We need to control guns. And then a really good friend of mine in graduate school, she's a woman and she lived in Berkeley on the south side of campus, and I spouted this view and she said, John, I have a gun.

I went, what? I said, yeah, I live in an apartment in a bad neighborhood on the south side of campus. I'm a woman. I live alone. If somebody breaks in, the cops aren't going to come. It's right under my bed. Now, I don't want to necessarily agree with that or not, but it was a moment that shook me and made me realize I hadn't thought through this issue and Maria's got a point. So thank you, Maria, and thank you everybody else who has enlightened me about something that I hadn't thought about and more deeply, those experiences have enlightened me. Don't disparage things, don't go along too easily with the flow. Learn about it and only disparage it after you've learned about it, you're really sure you know what you're talking about.

Juliette Sellgren 
Once again, I'd like to thank my guest for their time and insight, and I'd like to thank you for listening to the Great Antidote podcast. The Great Antidote is sound engineered by Rich Goyette. If you have any questions, any guests or topic recommendations, please feel free to reach out to me at the great Thank you.