#172 John Cochrane On The Fiscal Theory Of The Price Level, Causes Of Inflation, And The Need To Stop Throwing Money Down Trillion-dollar Rat Holes

John Cochrane, the Rose-Marie and Jack Anderson Senior Fellow at the Hoover Institution and former professor of finance at the University of Chicago Booth School of Business and, before that, the Department of Economics, joins Julia on episode 172. Professor Cochrane is the author of The Fiscal Theory of the Price Level book, and he writes the Grumpy Economist blog. and In this episode, Professor Cochrane discusses the current state of the US economy, the fiscal theory of the price level, the causes and challenges of inflation, and the concerning levels of government debt. He emphasizes the need for supply-side efficiency and fiscal discipline to sustain economic growth and control inflation. Cochrane also highlights the limitations of the Federal Reserve's interest rate policy and the importance of responsible fiscal policy in addressing the fiscal picture. He suggests reforming the tax code, social programs and reducing middle-class subsidies are necessary to ensure long-term sustainability. 

Cochrane concludes by emphasizing the need to pay attention to incentives and the interconnectedness of various policies. He also mentions the potential of AI and biotech to drive future growth and warns against stifling innovation.

Takeaways: 

• The US economy is currently experiencing low unemployment and a bout of inflation caused by government stimulus.
• The fiscal theory of the price level explains that money, government debt, and inflation are interconnected, and the quantity of money and government bonds both impact inflation.
• The Federal Reserve's interest rate policy has limitations in controlling inflation, and fiscal policy plays a crucial role in addressing inflation and government debt.
• To fix the fiscal picture, it is necessary to reform the tax code, social programs, and reduce middle-class subsidies to ensure long-term sustainability.
• Responsible fiscal policy, economic growth, and steady primary surpluses are essential to control inflation and maintain a stable economy. The US economy may be more fragile than it appears, with concerns about the ability to pay back debts and the difficulty of selling longer-term debt.
• Forecasting inflation is challenging, and the Federal Reserve and other forecasters have often missed the mark. The mechanics of inflation are similar to the stock market, and there are risks of higher inflation in certain scenarios.
• Fiscal dominance refers to the constraint on monetary policy caused by fiscal policy. The ability to control inflation through fiscal policy may be more challenging now.
• The Federal Reserve was slow to act on inflation and needs to consider a wider range of scenarios and incentives in its decision-making process.
• The biggest economic story in our lifetimes is long-term growth and the importance of embracing new technologies and innovation. Incentives play a crucial role in solving economic problems and driving growth.
• Social programs and the tax code need to be examined together to understand the full impact on incentives and redistribution.
• The interconnectedness of policies and the need to consider the whole system when addressing economic challenges.

Links:

Twitter/X: https://x.com/JohnHCochrane

Website: https://www.johnhcochrane.com/

Substack: https://substack.com/@grumpyeconomist

Book: https://www.amazon.com/Fiscal-Theory-Price-Level/dp/0691242240

Timestamps: 

00:00 Intro and welcome John Cochrane 

01:30 Macro picture and understanding inflation

04:00 We’re a supply-limited economy, more money and stimulus thrown down ratholes won’t make the economy grow 

05:30 The Fiscal Theory of the Price Level

11:35 Limitations of the Federal Reserve's interest rate policy

17:00 History lesson on 1970s, 1980s inflation 

19:00 Fiscal picture today and possible solutions 

25:00 The fragility of the US economy

31:00 More persistent inflation

37:55 Fiscal Dominance

41:00 Assessing the Fed's actions

48:00 Long-run growth is the only thing that matters

53:00 The Role of Incentives