The economist 19 november 2011 pdf

A shift in demand from services to durables can make durable prices go up. But it would make services prices go down. It is telling that inflation was a complete surprise to the Federal Reserve. The Fed failed twice. First, the economy did not need demand-side stimulus. Insurance was wise, and forestalling a financial crisis was necessary. But sending money to every citizen to stoke demand was not.

Second, the Fed being surprised by supply shocks is as excusable as the Army losing a battle because its leaders are surprised that the enemy might attack.

By this calculation, the 6 percent or so cumulative inflation we have seen so far leaves a way to go. But people may think some of the debt will be repaid. If they think half will eventually be repaid, then the price level need only rise 15 percent overall.

But then it stops. A one-time unbacked debt increase leads to a one-time price-level increase, not continuing inflation. Whether inflation continues or not depends on future monetary policy, future fiscal policy, and whether people change their minds about overall debt repayment. Fiscal policy may not be done with us yet. If unbacked fiscal expansions continue—that is, borrowing when people do not expect additional repayment—then additional bouts of fiscal inflation will occur.

Higher tax rates do not necessarily mean higher revenues, if economic growth falters; and even so the proposed taxes do not cover the proposed spending increases even with static scoring. If so, even more inflation can break out, seemingly as always out of nowhere. Fiscal and monetary policies are always intertwined in causing or curing inflation. Even in a pure fiscal theory of the price level, monetary policy setting interest rates can control the path of expected future inflation.

Thus, whether inflation continues or not also depends on how monetary policy reacts to this fiscal shock and its consequences. Whether the Fed will do something about it is an obvious concern. In recent U. Will our Fed really do that? Will our Congress let our Fed do that?

If the Fed needs to fight inflation, fiscal constraints on monetary policy will play a large and unexpected role. In , the debt-to-GDP ratio was 25 percent. Today it is percent, and rising swiftly. Fiscal constraints on monetary policy are four times larger today, and counting. For a rise in interest rates to lower inflation, fiscal policy must tighten as well. Without that fiscal cooperation, monetary policy cannot lower inflation. There are two important channels of this interconnection.

First, the rise in interest rates raises interest costs on the debt. The government must pay those higher interest costs, by raising tax revenues and cutting spending, or by credibly promising to do so in the future.

This consideration is especially relevant if the underlying cause of the inflation is fiscal policy. In a fiscally driven inflation, it can happen that the central bank raises rates to fight inflation, which raises the deficit via interest costs, and thereby only makes inflation worse.

This has, for example, been an analysis of several episodes in Brazil. Second, if monetary policy lowers inflation, then bondholders earn a real windfall. Fiscal policy must tighten to pay this windfall. People who bought year Treasury bonds in September of got a By this back of the envelope calculation, those bondholders got an amazing 12 percent annual real return. That return came completely and entirely courtesy of U.

The tax reform and deregulation, which allowed the United States to grow strongly for 20 years, eventually did produce fiscal surpluses that nearly repaid U. At percent debt-to-GDP ratio, each 5 percentage point reduction in the price level requires another 5 percent of GDP fiscal surplus.

Ask yourself, if inflation gets built into bond yields, and the Fed tries to lower inflation, will our Congress really raise tax revenues or cut spending in order to finance an unexpected by definition and undeserved it will surely be argued windfall profit to wealthy investors, foreign central bankers, and fat-cats on Wall Street?

If it does not do so, the monetary attempt at disinflation fails. We state too casually that that the United States will always repay its debts, and prioritize that repayment over all else.

We should not take such probity for granted. For example, in the debt ceiling discussion, it stated as fact by all concerned, from the Treasury to Congress to the White House, that hitting the debt ceiling must trigger a formal default.

That is untrue. The United States could easily prioritize its tax revenues to repaying interest and principal on outstanding debt, by cutting other spending instead. Painful, yes. Impossible, no.

That the U. And with inflation, we are not even talking about formal default. The question is, will the United States undertake a sharp fiscal austerity to support monetary policy in the fight against inflation, by paying higher interest costs on the debt and by repaying bondholders in more valuable money?

Or will the government just repay as promised, but in dollars that are worth more than expected? If the government does the latter, monetary policy fails.

There is a third troublesome requirement for higher nominal interest rates to produce lower inflation. One needs an economic model in which this is true, that model needs to be correct, and its preconditions need to be met.

So you need an understanding of how and when things work the other direction in the short run. A widely expected rise in nominal interest rates raises inflation. Both preconditions are questionable today. More complex ingredients, such as long-term debt or financial frictions, can allow a higher nominal rate to temporarily lower inflation.

But reliance on more complex ingredients and frictions is also dangerous. The future is not hopeless. Inflation control simply requires our government, including the central bank, to understand classic lessons of history. Forestalling inflation is a joint task of fiscal, monetary, and micro-economic policy. Stabilizing inflation once it gets out of control is a joint task of fiscal, monetary, and micro-economic policy. Fiscal surpluses do not result from sharply higher tax rates, especially of a tax system so riven with economic distortions as ours.

Fiscal surpluses can come from spending restraint, but that too is difficult. The best road to fiscal surpluses is strong economic growth, which increases the tax base and lowers the need for social spending.

In the conundrum between taxes and spending, there is a way out: raise long-term economic growth. And there is only one way to do that: to increase the supply-side capacity of the economy. That is, however, just as politically controversial as the first two options. Most of the job is to get out of the way. Most economic regulation is designed to transfer incomes, to protect various interests, or to push on the scales of bilateral negotiation, to undo the harsh siren of economic incentives, in a way that stifles economic growth.

Many interests hate pro-growth legislation and regulation just as much as they hate taxes and spending cuts. The work disincentives of social programs—paying people not to work, bluntly—are laid bare. All successful inflation stabilizations have combined monetary, fiscal, and micro-economic reforms. I emphasize reforms. In most cases the tax system is reformed to provide more revenue with less distortion. The structure of spending programs is reformed to help people in need more efficiently without work disincentives.

Regulations are reformed, though they hurt the profits of incumbents, to increase entry, competition and innovation. The policy regime is changed, durably. The economy took off, so by the late s economists were seriously writing papers about what to do when the federal debt had all been repaid.

Many monetary stabilizations have been tried without fiscal and microeconomic reform. They typically fail after a year or two.

The history of Latin America is littered with them Kehoe and Nicolini The high interest rates of the early s likely represented a fear that the United States would suffer the same fate.

The s were not just a failure of monetary policy. These points are especially important if the inflation turns in to a sustained s inflation, as the inflation turned in to a sustained s inflation. For this time, the roots of inflation will most likely be fiscal, a broad change of view that our government really will not eventually reform and repay its debt.

The only fundamental answer to that question will be, to reform and set in place a durable structure that will repay debt. Monetary machination will be pointless. A small bout of inflation may be useful to our body politic. Inflation is where dreams of costless fiscal expansion, flooding the country with borrowed money to address every perceived problem, hit a hard brick wall of reality.

A small bout of inflation and debt problems may reteach our politicians, officials, and commentariat the classic lessons that there are fiscal limits, fiscal and monetary policy are intertwined, and that a country with solid long-term institutions can borrow, but a country without them is in trouble, and one must allow the golden goose to thrive if one wants to tax her eggs.

A small bout of inflation may reteach the same classes that supply matters, incentives matter, and sand in the gears matter. The s reforms only happened because the s were so painful. In the meantime, however, there is one technical thing the Fed and Treasury can do to forestall a larger crisis: borrow long.

Interest costs feed into the budget as debt rolls over. If the United States borrows long-term, then higher interest rates do not raise interest costs on existing debt at all.

Shifting to long-term debt would remove one of the main fiscal constraints on monetary policy. The Federal Reserve has not helped this fiscal constraint, by transforming a fifth of the federal debt to overnight, floating-rate debt. The year Treasury rate is, as I write 2 percent, about negative 1 percent in real terms.

Okay, the 1-year rate is 0. As long as this lasts, the government seems to pay lower interest costs. But a 1. The window of opportunity will not last long, however, as interest rates are already creeping up. Cochrane, J. Available at www. Princeton, N. Manuscript available until publication at www. Friedman, M. Chicago: Aldine. Kehoe, T. Minneapolis: University of Minnesota Press. Increase the duration of the debt is the answer. I thought Greenspan was wrong when he went focused on lowering duration and concentrating on 10 year notes rather than 30 yr bonds.

Issue 30, 50, and year bonds. America might be the only country that could get that done at low interest rates. Greenspan wasn't Treasury Secretary at that time. You can lay the responsibility for that choice at the feet of Treasury Secretary Robert Rubin and his deputy Larry Summers.

Perhaps Treasury should sell something for instance equity that the Fed can't legally purchase? Even in the Obama-era stimulus spending, the administration emphasized promises of eventual debt reduction. The Obama administration's "stimulus" was primarily a debt swap private banking debt for public Treasury debt. Total debt public and private grew at That's what the government is already doing: issuing perpetuities.

Since, as you said in your post, nobody is expecting the government paying back the debt ever, it is issuing perpetuities. True, the perpetuities the government is issuing now include a "feature": they have "liquidity windows" on which the government will attempt, on a best effort basis, to find other investors that provide the liquidity the bonds you hold today. Since the risk is all on the hands of the present investors they have no collateral to claim and no assets will be seized if the government fails to find new suckers in those liquidity windows this feature is, mostly, irrelevant and does not make a big difference with actual perpetuities.

El Emperador, True perpetuities have no roll over or redemption date. The petpetuities that the central bank is issuing are the FRN's that they use to purchase the Treasury bonds. I think that if the US tries to place perpetuities right now it would fail. No one will take that duration risk in a new thin market well maybe Goldman would stuff it into their customer's portfolios.

It may be seen as a sign that an adult is in charge at Treasury, or seen as a sign that the Government is finally seeing the problems above and preparing for a crisis. The pandemic accelerated retirement for a large chunk of baby boomers. Women leaving the workforce to take care of children because schools and daycares being unavailable.

Women still have the highest demand for temporal flexibility. Fear of returning to work for fear of getting infected. Not an unreasonable fear.

Guilting and shaming people back to work is rarely useful. A game of chicken between employers and employees. The demand for temporal flexibility is increasing amongst both genders. Non-pecuniary benefits are becoming more important. Who will flinch first?

The fiscal helicopter drops weren't just for saving consumption. It was used to pay rent and also to pay down debt. As the blizzard is largely over, yes, those with cash in hand need an asbestos wallet so it doesn't burn a hole in their pockets. But the labor shortages are creating cost push inflation on top of demand pull.

But let's not lay the blame for the dysfunctional labor market at the feet of the fiscal side for plugging a huge hole due to lockdowns. All else equal, I would prefer more in depth discussion on how the fiscal theory and monetary theory differ. The "Really? I worry that someone who believes the monetary theory might argue that this does not represent their views. The truth is that borrowing activities in general have inflationary effects. In the past when most borrowings are in the form of bank loans, monetary aggregates are a good proxy of borrowing activities since loans create deposits which go into M2.

Nowadays that bonds player a much greater role, bond issuances including by the government which is fiscal policy are also inflationary, even when they just involve transfer of money between non-bank sectors and hence do not affect M2. So sandwich price goes up while total deposits M2 say the same. For once that's not a typo. I could have phrased that more clearly. You had me at Pure gold no pun intended. I see people thinking this is the Best of Times I thought it stood for Magical Monetary Theory.

My mistake, I guess. Or Nagical Money Tree. It's a structural shift away from Monetary policy to the Fiscal side. Problem is that assuming taxes will take out excess supply and then redistribute all over again?

I have doubts about that mechanism but maybe I got it wrong. There will still be tax avoidance and evasion. The effectiveness lag of Fiscal is immediate compared to that of the Fed. But the Fed wins on the implementation side. Michael Hudson. The interview is more wide-ranging than the title suggests but, with razor-sharp intellect, Dr.

Order Now. Name: E-mail:. Hudson for years. Inevitably, we have to go and listen again, to get the full flavor of what he is telling us. Thank you, Saker, for presenting this interview to us!! An excellent video on the true state of the US economy Wall Street and politics in general, certainly worth the time to watch! Thanks is why we need to invest in Gold in order to preserve our wealth.

Now you could do it online with this awesome ecosystem. Investing in gold, wee bits of paper and holding physical gold, wee bits of metal, are two entirely different things.