## How Inflation Radically Changes Economic Ideas by John Cochrane

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## Bibliographic details
- Authors: JOHN H COCHRANE
- Published: March 4, 2024

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### Central thesis and overview
- The unexpected resurgence of inflation demonstrates that the consensus ideas of economic policy are wrong and need to change.
- The “new” ideas needed are characterized as well tested and available: supply-oriented, incentive-focused, and fiscally prudent policies.
- Inflation comes when aggregate demand exceeds aggregate supply.

### Causes of recent inflation (demand vs. supply)
- Fiscal expansion as a primary source of demand:
  - The US government sent about $5 trillion in checks to people and businesses.
  - $3 trillion of that was newly printed money, with no plans for repayment.
  - Other countries enacted similar fiscal expansions and reaped inflation in proportion.
- Supply considerations:
  - Supply did shrink during the pandemic, but inflation spiked after the pandemic was largely over.
  - Many “supply shock” industries were producing as much as before but could not keep up with demand.
- The precise share of inflation from demand versus reduced supply matters little to the core lesson: supply (productive capacity) is far more limited than previously thought.

### Implications for growth and policy orientation
- A supply-limited economy requires supply-oriented policy, not stimulus.
- Jobs characterized as make-work are a cost, not a benefit, when unemployment is low:
  - US unemployment cited as 3.7 percent.
- Policies and reforms advocated to increase productive capacity and incentives:
  - Reduce regulations that make housing costly and time-consuming to build.
  - Implement a coherent immigration system to bring in workers who produce and pay taxes.
  - Invest in public infrastructure, but be mindful of “obscene excess cost.”
  - Eliminate tariffs that force overpayment for goods foreigners can provide more efficiently.
  - Focus redistribution policy on incentives that promote growth.

### Fiscal constraints and borrowing limits
- The view of unlimited demand for government debt has proved false:
  - The US, UK, and Europe seem to be able to borrow about 100 percent of GDP.
- Consequences of more debt:
  - More debt leads to higher interest rates, trouble borrowing, and inflation as people try to spend the extra debt rather than hold it.
- Governments must spend as if they have to raise taxes to pay for it, now or later.
- Projections that debt will serenely grow to 200 percent of GDP under primary deficits that are eternally 5–10 percent of GDP will simply not happen.
- Fiscal capacity is diminished for future shocks:
  - If the $5 trillion pandemic response was more debt than people will hold and caused inflation, the $10 trillion response to the next crisis will face even more trouble.

### Critique of subsidy- and industrial-policy approaches
- Left-wing proposals: spending trillions on cost-ineffective climate subsidies (example given: massively oversize electric cars built in the US, by union labor, with US parts).
- Right-wing proposals: spending trillions on protection and industrial subsidies to revive 1950s manufacturing.
- Warning: industrial policy risks repeating harmful effects (example: Jones Act parallels), and now that money is no longer free, spending must be effective.

### Monetary and financial lessons
- Two deep lessons for monetary and financial policy:
  - Central banks do not entirely control inflation; inflation control needs fiscal probity as well.
  - The fiscal blowout included a financial bailout of Treasury, municipal, and corporate debt; money market funds; airlines; and others.
- The “no more bailouts” promise of Dodd-Frank failed; extensive regulation (another 100,000 regulations) is unlikely to solve the underlying issues.
- The proposed solution: return to the classic vision of equity-financed banking.

### Broader intellectual and methodological points
- Progress in economics comes from patiently worked out, empirically verified answers that simplify reality into actionable cause-and-effect statements—not from ad hoc “novel” ideas or political demands for the appearance of novelty.
- The mantras of the 2010s—“secular stagnation,” “modern monetary theory,” “stimulus”—are deemed invalidated by recent inflation outcomes.
- Historical perspective: Adam Smith’s ideas, described as 250-year-old, remain relevant and informative for current policy debates.

*Source: How Inflation Radically Changes Economic Ideas by John Cochrane, F&D Magazine, March 2024.*

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## Content in this bundle

- **How Economics Must Change — John H. Cochrane**
  - [How Economics Must Change — John H. Cochrane (Markdown version)](/-/media/files/publications/fandd/article/2024/03/how-econ-must-change-cochrane.pdf.md){rel="alternate" type="text/markdown"}
  - [How Economics Must Change — John H. Cochrane (PDF)](/-/media/files/publications/fandd/article/2024/03/how-econ-must-change-cochrane.pdf){rel="external" type="application/pdf"}

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_Source: https://www.imf.org/en/publications/fandd/issues/2024/03/symposium-how-inflation-radically-changes-economic-ideas-john-cochrane_