These are my prepared comments for the session “Inflation and the Macroeconomy” at the 2025 American Economic Association annual meetings, with Jason Furman, Ben Bernanke, and Christina Romer.
Why would anyone think that federal debt will be repaid? So far as I know, not one penny of federal debt that existed when I was born 76 years ago has been repaid. Why should anyone expect anything but ever larger deficits and ever larger cumulative federal debt?
I've been wondering the same thing. Seems to me it's similar to a private individual wanting to borrow a bunch of money. Any wise lender will analyze the person's ability to repay based on their existing level of debt, their income, and such factors. Having paid off a debt is not that important. But the likelihood that I will repay is what counts. A lender does not consider a borrower a good risk if they are always spending beyond their means with no foreseeable way to pay it back.
So I'm imagining it's the same with federal borrowing and spending. People, institutions and nations may be willing to loan money to a govt when the fiscal house is in order. Some amount of existing debt is fine (just like individuals carry large long-term debts like mortgages and can still borrow money). But somewhere there is a limit where the numbers don't add up any more and the only assurance you have of being repaid for your loan to the govt is the word of the govt.
So we may actually continue having larger deficits and larger cumulative debt. Not my idea of wise living, but maybe it's allowable if we also have even LARGER increases in revenue. Ah, there's the problem. Seems to me we are on shaky ground. I'd be a little less likely to buy a T-bill these days.
At least that's how I understand it, having only had Economics 101 in college
Less repaid than refinanceable, in my view. If both debt and nominal GDP grow at 4-5 pct and debt stays stable where it is (around 100 pct GDP) we shouldn’t have any issue refinancing and the asset value of the US easily supports the debt. His focus in primary surplus is instructive.
If debt and deficits continues to spiral higher (they likely will due to demographics and possibly exogenous shocks like war and domestic crises, pandemics, etc) then we are going to get more inflation. His comment about fiscal space is also instructive.
In my view there is no reason that spending outside of social security and Medicare (which have demographic issues) should be in deficit at full employment. Balance all of the non-payroll tax programs, and the residual deficits in payroll taxes are manageable. Once non/old age spending is on a sustainable path we can turn to “fixing” social security and Medicare. We should never “fix” them first as any savings there will merely be spent (Medicare “savings” were used to justify deficit spending on Obamacare and the IRA via budget reconciliation). We have to demonstrate prudence on the whole budget before we try to “fix” the old age stuff, IMO.
Really appreciate your clear thoughts on inflation. I do have a question about this statement :
”It’s hard to know how much faith people have that debt will be repaid.”
Do we not have a good understanding of this via medium/longer term bonds’ interest rates? Ie, if there were fear of repayment, interest rates would go up?
Not to worry- the Fed’s omertà concerning fiscal policy has just ended with Trump’s election (as noted in the speculative fiscal commentary from the last Fed meeting). Pledging to hand out $100 billion a year in student loan forgiveness above and beyond the budgeted 6 pct deficits at full employment was never worthy of comment but suddenly speculation about tariffs is part of the Fed playbook.
All it takes is a Repub in power for central bankers to find their spines (see also: the 200bp of Fed tightening and shift to QT immediately after Trump’s 2016 election despite PCE sub 2 pct) and for the media to realize they need to be sceptical of those in power.
In all seriousness, thank you for the excellent summary of what happened and what could happen.
Your analysis of what caused inflation is right on the money. Thanks to fiscal and monetary stimulus, real personal disposable income rose 11% and M2 rose 25% in 2020, a year when real GDP DECLINED 2%. Then, in 2021, we started to spend our ill-gotten gains. As Biden entered office, serious inflation was baked in the cake. The question is why economists were incapable of seeing it coming at the time.
But I did. My March 2021 post "Ain't Nothin' but a Party" was the only article I am aware of that correctly predicted our inflation problem. No brag, just fact.
Now, given our political and cultural disfunction, inflation is our inexorable future.
Oh, and heads up for failed Treasury auctions. Sooner rather than later. The primary dealers are choking on all the product; the system does not have enough capital
Great analysis, at least for this interested layman to understand. I’ll point out the binge was not a response to the pandemic, at least in the Biden Administration’s case. It was the cynical application of Rahm Emanuel’s maxim to not let a crisis go to waste. Coupled with Pelosi’s iron discipline to keep the troops in line, they were able to pass almost their entire wishlist as the “Inflation Reduction Act”.
This is great. Clearer than the average economics tract. And clearly lays out the real problem - long term fiscal dysfunction. If only economists could fix fiscal dysfunction.
Wow, all wrong. Not surprising considering Substack is a steaming pile of manure. February 2021 is when the vaccines started rolling out and things started going back to normal…but we were always going to have inflation in 2021 because we had deflation in March and April and May of 2020 and so the Fed was fine with numbers superficially high in 2021 in light of the deflation months falling out of the headline numbers.
And anyone that doesn’t factor in the unprecedented weather events in TX/LA beginning in August 2020 is a partisan hack…because we all know how Katrina impacted inflation in 2005/06. So the unprecedented weather events in the most important energy producing region along with Putin’s asinine invasion of Ukraine exacerbated energy inflation which is what people are referring to when they say “9.1% inflation”. Btw, we had 5.5% inflation in July 2008 and Republicans thought that was awesome because energy companies were making windfall profits and the energy industry is 99% Republican.
Anyway, the inflation was a little about fiscal policy but mostly about excess savings from the Zoom class jacking up housing prices and supply chain disruptions that are still going on with things like HVAC parts (who is buying HVAC parts willy nilly?) and Putin’s asinine invasion of Ukraine after unprecedented weather events disrupted North American energy production coming out of the pandemic.
“Debt that will be repaid doesn’t cause inflation.” I am not sure what the percentage is for the USD, but in Australia 97% of the M3 money consists of bank-issued Credit. Credit attracts interest which must be repaid on top of the principal, therefore credit can never be repaid with hard money (the money created by the central bank) but must be either rolled over into ever more credit or written off as bad debt. Low interest rates drive the temporary-money creation known as credit. Yes?
Thanks for an intellectually consistent and comprehensive survey of a complex topic.
Would you mind a couple of questions on two statements that struck me in your piece?
1) “Raising interest rates helps bring down inflation more quickly, but at the cost of somewhat more persistent inflation”
Do I understand correctly that the quick(er) bringing down of inflation following a rise in interest rates is explained by familiar ‘Keynesian’ effects and the associated greater persistence of inflation is explained by the effect on the discounted value of future primary balances (which is reduced by an increase in interest rates)?
2) “Fundamentally, inflation comes from debt we won’t or can’t repay. Long run tax revenue is good for inflation, but that mostly comes from more growth not higher tax rates.”
It seems to me that this statement is incomplete at best. Correcting the expectation that debt may not be repaid requires creating the expectation of future higher primary surpluses, ie, higher revenues or lower expenditures as share of GDP. Relying on higher GDP growth to achieve this at the very least implicitly assumes that the growth of expenditures will be kept below that of GDP. I guess that most people would consider this an expenditure reduction, especially for expenditure exhibiting persistent trends to grow more than GDP.
BTW I suspect that you should clarify to the readers the concept of ‘debt repayment’ over an infinite horizon.
The "fiscal narratives" essay gives an explanation of how higher interest rates lower inflation temporarily. I was indeed brief here. Yes, higher GDP means higher tax revenue (tax rate x GDP) but only helps the deficit if spending grows less than GDP.
If I understand the explanations in the fiscal narratives, higher interest rates can lower inflation in the short run only because of the existence of long-term debt. The real value of the stream of interest payments from
and repayment of the long-term debt must go down if interest rates are raised. This implies a transfer of resources from the holders of such debt until it is fully rolled over. Since nothing happens to the sequences of primary surpluses, this transfer must be matched by a rise in the real value of interest payments from and repayment of short-term debt. The overall transfer takes is reflected in a temporary decrease in inflation relative to baseline followed by a more persistent increase. Is this a correct understanding? If all debt were continuously rolled over there would be no transfer of resources from bondholders and therefore the rise in interest rates would be immediately match by the rise in inflation, wouldn’t it? What about the opposite case of debt never being rolled over? What would be the counterpart of the transfer of resources from bondholders?
Excellent set of comments for the AEA meeting. Can someone answer this profound but puzzling comment? What the mechanism by which 'people do not expect the new debt to be repaid'? Is Cochrane referring to bondholders? Certainly not the general class of voters who were privately forecasting in unison this sequence of events. There must be behavioral forces at play here...
"debt and deficits only cause inflation when people do not expect the new debt to be repaid by higher future surpluses. Debt that will be repaid doesn’t cause inflation".
Best analysis I've read in years... even better the second time thru. Masterful. Curious as to how it was received by Bernanke/Romer/Furman et al... can't imagine they're ready to admit to/agree with the policy-whiffs that by now have become all too obvious.
I hope your work is heard/read by the new administration. I'm optimistic but realize the sisyphean task ahead. I also suggest that you get on the 2025 schedule to present this to the "Markus' Academy" (Princeton hosted group). Thank you, Professor
Especially this sentence: "In our reformulation, the Taylor principle is inverted: determinacy is obtained when nominal rates respond less than one-for-one to inflation. This feature is desirable because it means that determinacy is not achieved through exuberant off-equilibrium threats"
Why would anyone think that federal debt will be repaid? So far as I know, not one penny of federal debt that existed when I was born 76 years ago has been repaid. Why should anyone expect anything but ever larger deficits and ever larger cumulative federal debt?
I've been wondering the same thing. Seems to me it's similar to a private individual wanting to borrow a bunch of money. Any wise lender will analyze the person's ability to repay based on their existing level of debt, their income, and such factors. Having paid off a debt is not that important. But the likelihood that I will repay is what counts. A lender does not consider a borrower a good risk if they are always spending beyond their means with no foreseeable way to pay it back.
So I'm imagining it's the same with federal borrowing and spending. People, institutions and nations may be willing to loan money to a govt when the fiscal house is in order. Some amount of existing debt is fine (just like individuals carry large long-term debts like mortgages and can still borrow money). But somewhere there is a limit where the numbers don't add up any more and the only assurance you have of being repaid for your loan to the govt is the word of the govt.
So we may actually continue having larger deficits and larger cumulative debt. Not my idea of wise living, but maybe it's allowable if we also have even LARGER increases in revenue. Ah, there's the problem. Seems to me we are on shaky ground. I'd be a little less likely to buy a T-bill these days.
At least that's how I understand it, having only had Economics 101 in college
Less repaid than refinanceable, in my view. If both debt and nominal GDP grow at 4-5 pct and debt stays stable where it is (around 100 pct GDP) we shouldn’t have any issue refinancing and the asset value of the US easily supports the debt. His focus in primary surplus is instructive.
If debt and deficits continues to spiral higher (they likely will due to demographics and possibly exogenous shocks like war and domestic crises, pandemics, etc) then we are going to get more inflation. His comment about fiscal space is also instructive.
In my view there is no reason that spending outside of social security and Medicare (which have demographic issues) should be in deficit at full employment. Balance all of the non-payroll tax programs, and the residual deficits in payroll taxes are manageable. Once non/old age spending is on a sustainable path we can turn to “fixing” social security and Medicare. We should never “fix” them first as any savings there will merely be spent (Medicare “savings” were used to justify deficit spending on Obamacare and the IRA via budget reconciliation). We have to demonstrate prudence on the whole budget before we try to “fix” the old age stuff, IMO.
Really appreciate your clear thoughts on inflation. I do have a question about this statement :
”It’s hard to know how much faith people have that debt will be repaid.”
Do we not have a good understanding of this via medium/longer term bonds’ interest rates? Ie, if there were fear of repayment, interest rates would go up?
Not to worry- the Fed’s omertà concerning fiscal policy has just ended with Trump’s election (as noted in the speculative fiscal commentary from the last Fed meeting). Pledging to hand out $100 billion a year in student loan forgiveness above and beyond the budgeted 6 pct deficits at full employment was never worthy of comment but suddenly speculation about tariffs is part of the Fed playbook.
All it takes is a Repub in power for central bankers to find their spines (see also: the 200bp of Fed tightening and shift to QT immediately after Trump’s 2016 election despite PCE sub 2 pct) and for the media to realize they need to be sceptical of those in power.
In all seriousness, thank you for the excellent summary of what happened and what could happen.
“It’ not a puzzle. This episode neatly fits two of the most classic stories, that we routinely tell undergraduates.”
Did others on the panel agree? Disagree? In what way?
Your analysis of what caused inflation is right on the money. Thanks to fiscal and monetary stimulus, real personal disposable income rose 11% and M2 rose 25% in 2020, a year when real GDP DECLINED 2%. Then, in 2021, we started to spend our ill-gotten gains. As Biden entered office, serious inflation was baked in the cake. The question is why economists were incapable of seeing it coming at the time.
But I did. My March 2021 post "Ain't Nothin' but a Party" was the only article I am aware of that correctly predicted our inflation problem. No brag, just fact.
Now, given our political and cultural disfunction, inflation is our inexorable future.
Oh, and heads up for failed Treasury auctions. Sooner rather than later. The primary dealers are choking on all the product; the system does not have enough capital
https://charles72f.substack.com/p/aint-nothin-but-a-party
POSIWID :) http://mrzepczynski.blogspot.com/2024/12/posiwid-purpose-of-system-is-what-it.html
Great analysis, at least for this interested layman to understand. I’ll point out the binge was not a response to the pandemic, at least in the Biden Administration’s case. It was the cynical application of Rahm Emanuel’s maxim to not let a crisis go to waste. Coupled with Pelosi’s iron discipline to keep the troops in line, they were able to pass almost their entire wishlist as the “Inflation Reduction Act”.
This is great. Clearer than the average economics tract. And clearly lays out the real problem - long term fiscal dysfunction. If only economists could fix fiscal dysfunction.
Wow, all wrong. Not surprising considering Substack is a steaming pile of manure. February 2021 is when the vaccines started rolling out and things started going back to normal…but we were always going to have inflation in 2021 because we had deflation in March and April and May of 2020 and so the Fed was fine with numbers superficially high in 2021 in light of the deflation months falling out of the headline numbers.
And anyone that doesn’t factor in the unprecedented weather events in TX/LA beginning in August 2020 is a partisan hack…because we all know how Katrina impacted inflation in 2005/06. So the unprecedented weather events in the most important energy producing region along with Putin’s asinine invasion of Ukraine exacerbated energy inflation which is what people are referring to when they say “9.1% inflation”. Btw, we had 5.5% inflation in July 2008 and Republicans thought that was awesome because energy companies were making windfall profits and the energy industry is 99% Republican.
Anyway, the inflation was a little about fiscal policy but mostly about excess savings from the Zoom class jacking up housing prices and supply chain disruptions that are still going on with things like HVAC parts (who is buying HVAC parts willy nilly?) and Putin’s asinine invasion of Ukraine after unprecedented weather events disrupted North American energy production coming out of the pandemic.
“Debt that will be repaid doesn’t cause inflation.” I am not sure what the percentage is for the USD, but in Australia 97% of the M3 money consists of bank-issued Credit. Credit attracts interest which must be repaid on top of the principal, therefore credit can never be repaid with hard money (the money created by the central bank) but must be either rolled over into ever more credit or written off as bad debt. Low interest rates drive the temporary-money creation known as credit. Yes?
Thanks for an intellectually consistent and comprehensive survey of a complex topic.
Would you mind a couple of questions on two statements that struck me in your piece?
1) “Raising interest rates helps bring down inflation more quickly, but at the cost of somewhat more persistent inflation”
Do I understand correctly that the quick(er) bringing down of inflation following a rise in interest rates is explained by familiar ‘Keynesian’ effects and the associated greater persistence of inflation is explained by the effect on the discounted value of future primary balances (which is reduced by an increase in interest rates)?
2) “Fundamentally, inflation comes from debt we won’t or can’t repay. Long run tax revenue is good for inflation, but that mostly comes from more growth not higher tax rates.”
It seems to me that this statement is incomplete at best. Correcting the expectation that debt may not be repaid requires creating the expectation of future higher primary surpluses, ie, higher revenues or lower expenditures as share of GDP. Relying on higher GDP growth to achieve this at the very least implicitly assumes that the growth of expenditures will be kept below that of GDP. I guess that most people would consider this an expenditure reduction, especially for expenditure exhibiting persistent trends to grow more than GDP.
BTW I suspect that you should clarify to the readers the concept of ‘debt repayment’ over an infinite horizon.
The "fiscal narratives" essay gives an explanation of how higher interest rates lower inflation temporarily. I was indeed brief here. Yes, higher GDP means higher tax revenue (tax rate x GDP) but only helps the deficit if spending grows less than GDP.
If I understand the explanations in the fiscal narratives, higher interest rates can lower inflation in the short run only because of the existence of long-term debt. The real value of the stream of interest payments from
and repayment of the long-term debt must go down if interest rates are raised. This implies a transfer of resources from the holders of such debt until it is fully rolled over. Since nothing happens to the sequences of primary surpluses, this transfer must be matched by a rise in the real value of interest payments from and repayment of short-term debt. The overall transfer takes is reflected in a temporary decrease in inflation relative to baseline followed by a more persistent increase. Is this a correct understanding? If all debt were continuously rolled over there would be no transfer of resources from bondholders and therefore the rise in interest rates would be immediately match by the rise in inflation, wouldn’t it? What about the opposite case of debt never being rolled over? What would be the counterpart of the transfer of resources from bondholders?
Excellent set of comments for the AEA meeting. Can someone answer this profound but puzzling comment? What the mechanism by which 'people do not expect the new debt to be repaid'? Is Cochrane referring to bondholders? Certainly not the general class of voters who were privately forecasting in unison this sequence of events. There must be behavioral forces at play here...
"debt and deficits only cause inflation when people do not expect the new debt to be repaid by higher future surpluses. Debt that will be repaid doesn’t cause inflation".
Brilliant
Best analysis I've read in years... even better the second time thru. Masterful. Curious as to how it was received by Bernanke/Romer/Furman et al... can't imagine they're ready to admit to/agree with the policy-whiffs that by now have become all too obvious.
Again, great work John.
I hope your work is heard/read by the new administration. I'm optimistic but realize the sisyphean task ahead. I also suggest that you get on the 2025 schedule to present this to the "Markus' Academy" (Princeton hosted group). Thank you, Professor
Off topic, this paper caught my eye:
https://www.nber.org/system/files/working_papers/w33332/w33332.pdf
Especially this sentence: "In our reformulation, the Taylor principle is inverted: determinacy is obtained when nominal rates respond less than one-for-one to inflation. This feature is desirable because it means that determinacy is not achieved through exuberant off-equilibrium threats"
Maybe you already saw it?