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.
The inflation was so obviously transitory from bullwhip effect. But energy prices really did spike and that had to do with unprecedented weather events and Putin being a dumbass. Unprecedented weather events also impacted food supply. Shelter inflation is persistent and that is due to fiscal (Trump Tax Cuts and lockdown excess savings) and Fed kept rates too low…but we did have multi family supply disruptions and this year we will see apartments coming on line in the metros Americans herded to like Austin and Phoenix and DFW.
It’s more money in the economy going to people that are already doing well…it explains housing prices increasing and G-wagon price increase and Rolex price increase. Or do you believe a $1400 check allowed someone to buy a $750k house and G-wagon and Rolex??? Because if you believe that then we should send out $1400 checks every March and just accept 5% inflation!!! Because we would be a nation of wealthy assholes!!
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?
The models, which aren't only NK, say that with enough government debt issuance the Fed loses the ability to control the growth rate of M2. In this respect the models are correct.
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?
If debt is issued that everyone agrees won’t be repaid, for which the probability of default is 100%, it will be vaporized by an inflation spike that ensures the path of primary surpluses equals the outstanding debt. If debt issuance raises the probability of default and inflation goes up to zap the new, likely-to-not-be-repaid debt, why does the yield also have to rise?
Excellent!
The inflation was so obviously transitory from bullwhip effect. But energy prices really did spike and that had to do with unprecedented weather events and Putin being a dumbass. Unprecedented weather events also impacted food supply. Shelter inflation is persistent and that is due to fiscal (Trump Tax Cuts and lockdown excess savings) and Fed kept rates too low…but we did have multi family supply disruptions and this year we will see apartments coming on line in the metros Americans herded to like Austin and Phoenix and DFW.
Trump tax cuts! Yeah, that’s the ticket 😂
It’s more money in the economy going to people that are already doing well…it explains housing prices increasing and G-wagon price increase and Rolex price increase. Or do you believe a $1400 check allowed someone to buy a $750k house and G-wagon and Rolex??? Because if you believe that then we should send out $1400 checks every March and just accept 5% inflation!!! Because we would be a nation of wealthy assholes!!
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?
The models, which aren't only NK, say that with enough government debt issuance the Fed loses the ability to control the growth rate of M2. In this respect the models are correct.
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?
If debt is issued that everyone agrees won’t be repaid, for which the probability of default is 100%, it will be vaporized by an inflation spike that ensures the path of primary surpluses equals the outstanding debt. If debt issuance raises the probability of default and inflation goes up to zap the new, likely-to-not-be-repaid debt, why does the yield also have to rise?