In this little essay, I distilled several previous writings and my evolving FTPL talk on interpreting US inflation history via fiscal theory, with a particular focus on the 2021-2023 inflation. See my webpage here for a pdf version, slides, and updates. (That’s the more authoritative version.)
Question. What do these New Keynesian fiscal policy models predict happens if the Fed reduces the the quantity of M2, allowing it to grow only as fast as the past three years growth in nominal GDP? Is it really the case that the Fed cannot stop price inflation? Is it really the case that sustained growth in the price level cannot be stopped by reducing the growth rate of M2?
We hit 5.5% inflation year over year in 2008…that was real inflation due to high energy prices. The Fed however ignored that inflation because they believe energy prices are volatile…but the energy prices only appeared volatile because of the Katrina supply shock. Instead energy prices trended higher for the better part of a decade until the Financial Meltdown.
Question about FTPL, that I've been wondering. What are the microeconomic foundations of FTPL? That is, if big future deficits induce price level to rise, who are the economic actors that face incentives that create this phenomenom?
Another way of asking this is, if I had to study the behaviour of agents in the context of FTPL with micro data, what hypothesis would I be testing?
You write that "higher interest rates" can lead to inflation. Now, I think I broadly understand that merely looking at the FTPL basic equilibrium equation, you get higher level of prices via higher (real) rates, as higher (real) rates imply lower discount factors for government real surpluses.
But ... what is the economic intuition behind this equilibrium accounting? I struggle to find an intuitive explanation for this FTPL relationship between rates and inflation.
1) You write: "Why was there deflation? Why, especially given the large deficits, which superficially look like they ought to cause inflation? In the recession, though deficits rose, the real interest rate fell. Real interest costs on the debt fell." But real interest rates depend on inflation. Isn't there a way to explain what happened without consider how the object of the explanation behaved?
2) Overall, it reads like everything can be explained through FTPL, ex-post. Isn't there a measure of private expectations on future debt repayments that would help test - hence possibly falsify - the theory?
Excellent!
Question. What do these New Keynesian fiscal policy models predict happens if the Fed reduces the the quantity of M2, allowing it to grow only as fast as the past three years growth in nominal GDP? Is it really the case that the Fed cannot stop price inflation? Is it really the case that sustained growth in the price level cannot be stopped by reducing the growth rate of M2?
We hit 5.5% inflation year over year in 2008…that was real inflation due to high energy prices. The Fed however ignored that inflation because they believe energy prices are volatile…but the energy prices only appeared volatile because of the Katrina supply shock. Instead energy prices trended higher for the better part of a decade until the Financial Meltdown.
Excellent post, once again. Thank you.
Question about FTPL, that I've been wondering. What are the microeconomic foundations of FTPL? That is, if big future deficits induce price level to rise, who are the economic actors that face incentives that create this phenomenom?
Another way of asking this is, if I had to study the behaviour of agents in the context of FTPL with micro data, what hypothesis would I be testing?
Thanks for the article! I hope these fiscal narratives prove to be useful for the citizens.
Dear Professor
You write that "higher interest rates" can lead to inflation. Now, I think I broadly understand that merely looking at the FTPL basic equilibrium equation, you get higher level of prices via higher (real) rates, as higher (real) rates imply lower discount factors for government real surpluses.
But ... what is the economic intuition behind this equilibrium accounting? I struggle to find an intuitive explanation for this FTPL relationship between rates and inflation.
Kind regards,
S.
Very interesting. Two points:
1) You write: "Why was there deflation? Why, especially given the large deficits, which superficially look like they ought to cause inflation? In the recession, though deficits rose, the real interest rate fell. Real interest costs on the debt fell." But real interest rates depend on inflation. Isn't there a way to explain what happened without consider how the object of the explanation behaved?
2) Overall, it reads like everything can be explained through FTPL, ex-post. Isn't there a measure of private expectations on future debt repayments that would help test - hence possibly falsify - the theory?