People sometimes ask me how economics is different from that of John Cochran. In a recent Cochrane post on Fed independence, I found a paragraph that shows how our views differ.
Congress also gave the Fed a limited tool. The Fed can buy and sell securities and set interest rates. The Fed cannot print money directly and send it to people or businesses, nor confiscate the money. Doing so is much more powerful to control inflation than moving overnight interstrain, but only politically explainable institutions can tax or spend. Similarly, tax, labor regulations, and social programs exemptions affect far more jobs than federal funding rates, but the Fed cannot touch them. Even within its inflation and employment mandate, the Fed is forbidden to be the most powerful tool.
There have been many times when I agree with my own views more closely than John Cochran on the issue of government economic policy. However, this paragraph shows one essential difference. There are fundamentally different concepts of the nature of monetary policy. Cochrane makes two empirical claims, both of which I reject.
“Helicopter Drop” is much more inflation than open market purchases. Regulations have a greater impact on employment than monetary policy.
“Helicopter Drop” is a term used for financial combinations/financial injections. Therefore, the Fed can create $100 billion and give money to the public. In contrast, a $100 billion open market purchase (WIPO) includes a Fed that exchanges one asset (basic amount) for the equal value of another asset (Treasury security).
Cochrane believes that when “printing money and sending it to people,” the effect is much more inflationary than a simple OMP with the same amount of base amount. Financial/monetary injections can break down two separate steps. The Fed can do it with a $100 billion WPP, while the Treasury can simultaneously send $100 billion to the public with tax refunds. Unless I am wrong, Cochrane implicitly argues that the fiscal portion of its combined action is far more inflationary than the financial portion of the policy. (This is the involvement of price-level prosecutor’s theory.)
To simplify things, we will return to the pre-2008 financial regime and envision a permanent increase in exogenous and permanent financial bases made through open market purchases. This claims to have been a 10% increase over counterfactual piss routes that do not include a 10% base increase. When this policy was combined with a fiscal stimulus equivalent to saying tax rebates, I argue that it had only a small effect of inflation. In simple open market purchases, inflation is 10.5% or 11%, not 10%. Cochrane will argue that the total fiscal/Monterry injections are far less noticeable than simple OMPs haen haen.
[By the way, I believe my argument also applies to the post-2008 abundant reserve system, but it’s easier to see my point when we consider the simpler pre-2008 system, where 98% of the monetary base was currency. As an aside, Cochrane frames the discussion in terms of interest rates (which is the conventional view), but I don’t believe that interest rates tell us anything useful about why an exogenous and permanent 10% rise in the base causes a 10% rise in the price level.]
Why is currency injection so impactful? The public is primarily concerned about their actual cash balance. When you inject more currency into the economy, it doesn’t seem like the public wants to magically hold a large cash balance. Interad, the public tries to remove excess cash balances. This will increase the price by 10%. At that point, your actual cash balance will return to the desired level.
He also differs from Cochrane on employment issues. In my view, many of the biggest declines in employment are caused by Tigh Money Polities, including 1929–32, 1981–82, and 2008–09. This does not suggest that the regulations in the working market are not important. In fact, my views are more consistent with Cochrane than mainstream economists when it comes to questions such as minimum wage laws attributable to poverty programs, unemployment compensation, and marginal implicit tax rate outcomes attributable to poverty programs. So I’m not sympathetic to that point
Why are most economists different from me in Montarypoly? The I sub-pectie is primarily related to identification issues. When defining monetary policy as the current movement of money supply or the current movement of interstraight, there is little evidence that financial policies play a major role in job fluctuations or inflation shocks. In many cases, current movements in money and interference rates represent endogenous responsibility for the economic situation. In my view, it would be useful to consider monetary policy in terms of subject matter, such as consensus market forecasts for NGDP growth. Due to the indicators, monetary policy is extremely important.
Of course, my definition only makes sense if you think the Fed can control NGDP expectations through open market operations. Cochrane appears skeptical, while I believe they can. My two latest books provide an explanation of how I arrived at this approach to financial economics.
