Search the archive.

This massive influx in additional dollars has made the dollars already in our paychecks, pocketbooks and bank accounts worth less. As Milton Friedman explained, “Inflation is always and everywhere a monetary phenomenon, in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output.” In a recent study, the Federal Reserve Bank of San Francisco demonstrated how the American Rescue Plan directly pushed up prices in the economy. This painful inflation should put a nail in the coffin of Modern Monetary Theory, the belief held (at least in practice) by many Democrats that deficits don’t matter because money grows on trees via Federal Reserve printing. The inflation cost of MMT is proving high and painful. This philosophy also is responsible for the federal debt hitting $30 trillion, the net interest on which threatens to be a massive drag on the economy moving forward. High inflation also should drive a stake through the heart of the crackpot Democratic idea of universal basic income. Direct government payouts artificially boosted aggregate demand while at the same time contributing to the worst labor shortage in American history, reducing supply. Economists at The Committee to Unleash Prosperity estimate that most recipients of supplemental unemployment benefits made more than at their old jobs. The consequence: rapidly rising prices. Americans may think they are getting ahead when they receive a stimulus check. Certainly, that’s what the Democrats who support these basic income policies expect. But the higher incomes are ephemeral because they cause prices to rise, eliminating any real pocketbook gains. Support for universal basic income among some of America’s smartest technology innovators is proof that high intelligence doesn’t translate to sound public policy.

In order to fully appreciate how UBI would work, you need to look at what it’s implementation would do to an entire economy, not just a fraction of it. If everyone suddenly had an extra $10K a year, and everyone knew that everyone had an extra $10K a year, prices would go up and inflation would rise, thus negating the perceived gains of such a program. Think of it this way. If you walk into a store right now, the price of any product is based on the maximum amount of money it can command in exchange for it in relation to the number of customers needed to pay that price and keep it moving off the shelves at a predictable pace. In other words, supply and demand. However, this is based on the fact that the shop owner has no way of knowing the wealth level of every customer that walks into his store. Now, if Scrooge McDuck waddled in, the shop owner could assume his wealth, deduce that he could afford to pay more, and try to raise the prices on the fly. However, that would be tough because prices are usually clearly marked. But generally, that price is set using the knowledge that any single customer that walks in at any given time has a wealth baseline of $0 and an upper bound of, say, $112 billion. But, if you add in the knowledge that everybody that walks into your store, because of UBI, now has a wealth baseline of X+$10K, don’t you think that shop owner would charge more for his products? He knows you can afford a higher price now. These price rises would then have reverberations throughout the economy. As prices went up, wages would need to follow, which would make prices go even higher in an upward inflationary spiral. This is essentially Milton Friedman’s “helicopter money” analogy. It’s the same reason why, if you as an American (or westerner for that matter) have ever visited a market in a third-world country, the shopkeepers immediately jack up the prices because they know you can afford to pay more. You might as well be wearing golden robes and a diamond tiara. UBI is a subsidy, plain and simple, and if we’ve learned anything about subsidies, it’s that whenever you subsidize anything, you invariably raise its price, because you’ve lowered the cost to the consumer, and thus increased demand. If a Rube Goldberg machine is defined as something intentionally designed to perform a simple task in an indirect and over-complicated manner, then he’d award the concept of UBI a gold medal were he alive today. In the end, the simplest solution is usually the right one; just leave the money in the pockets of the people who earned it to begin with rather than conjure up new-fangled ways to redistribute it once you’ve taken it from them. They know better than you how to allocate it.

The case for a Universal Basic Income (UBI) is a strong one, in some ways. A UBI would stimulate aggregate demand, help those affected by technological change, and create a basic income for the poor. Its effectiveness and impact, however, depend on how much is given out. The benefits and consequences of a $100 UBI will be very different than one of $1,000. Therefore, for the purpose of this analysis, I will look at the case for a $1,000 per month UBI—as suggested by presidential candidate Andrew Yang. Previous Experiments Are Not Comparable First, it must be said that there are a number of cases that suggest UBI does, in fact, work. In Alaska, each resident gets up to $2,000 per year from the “Alaska Permanent Fund.” The state doesn't call it a UBI, but it works in a similar way. The difference, however, is that it is funded by its oil revenues. If oil prices go down, so do their dividends, which fell to $1,100 in 2017. Research by Damon Jones of the University of Chicago and Ioana Marinescu of the University of Pennsylvania found it had no impact on employment. However, this example and many others are not comparable to the $12,000 Yang proposes. Even European trials of UBI in Barcelona, Utrecht, and Helsinki only grant $590 per month. There is no conclusive evidence to suggest this would work in practice. While there have been many "successful" UBI trials, few have been tested at over $12,000 per year. There have been "successful" pilots in Namibia and India, but neither offered a comparable income. In Namibia for example, citizens received 100 Namibian dollars per month, or just over $7. In India, the trial gave each adult 300 Indian rupees per month, or just over $4. Although these sums may help the lives of those in the respective countries, they are not comparable to Yang's proposal. Previous experiments with UBI may suggest it would work, but they in no way represent the scale of $12,000. There is no conclusive evidence to suggest this would work in practice. While the late Milton Friedman is a source of inspiration, he only suggested a modest $300 negative income tax in 1962. In today’s money, this is equivalent to $2,500—far short of the proposed sum. Higher Prices and Inflation A UBI would essentially transfer wealth away from higher earners toward low earners. This spurs higher consumption because those with lower incomes have a higher propensity to consume. On a macro basis, this may not necessarily create any inflation, as there is no new money entering the economy. However, it will create inflation on a micro basis. Rather than money going toward investment, it is going toward consumer goods. Instead of inflation occurring through a wide variety of areas, it is being concentrated. Importance of Velocity Yang says this is just using the existing money in the economy. In part, he is right. However, he fails to consider the velocity of money. One of the reasons the US did not experience significant inflation after quantitative easing was due to a slowing of consumption growth. If we put $12,000 into everyone's hands, consumer demand will rise, and so, too, will velocity. When velocity increases, the same $1 exchanges hands at a quicker rate. For example, A may buy a television from B for $100. B will then buy a used iPhone from C for $100. C will then buy a used sofa from D for $100. The initial $100 has circulated around the economy at a value of $300. This sends demand signals to the relevant parties, who then respond with higher prices.

The OECD has just released a technical briefing paper (May 2017) – Basic Income as a Policy Option: Technical Background Note Illustrating Costs and Distributional Implications for Selected Countries – which, as the title suggests, explores the consequences of an “unconditional transfer paid to each individual” (BIG). It is a supporting document to a OECD policy brief (May 2017) – Basic Income as a Policy Option: Can it add up? . The OECD now has a research program it is calling – Future of Work. It turns out that my next book (written with Joan Muysken and to be published in 2018) will examine this topic. I will have more to say about the research we are engaged in for that project in the coming weeks. As before, you will be able to trace the notes I produce that will form the basis of this book via my blogs as the research process unfolds. The Technical Background paper provides “a more detailed description of … [the] … analysis, and shows more comprehensive results …” The OECD assumes that: 1. “a BI that would replace most cash benefits for working age households”. 2. “the provision of public services, such as health, education, care, or other in-kind supports is assumed to continue unchanged”. They note that if a government was “to take existing cash benefits paid to those of working age and to spread total expenditure on these benefits equally across all those aged below normal retirement age” the “resulting BI amount would be very much lower than the poverty line for a single individual”. Thus a “budget-neutral BI will be very far from eradicating poverty, whereas a BI set at the poverty line would be very expensive”. They demonstrate this using their Figure 1 (which I reproduce). So to aid interpretation, you can see that for Spain, for example, a BIG based on per-capita benefit spending would come up to around 35 per cent of the poverty line only, whereas the current social assistance benefit level is closer to 60 per cent of the poverty line (For a single-person household). In part, this arises as a result of the universality of the BIG. A targetted BIG is typically rejected by proponents. They add moral arguments to their narrative and claiming that a guaranteed minimum income is a right that all enjoy rather than only the poor. The OECD conclude that: … a BI at socially and politically meaningful levels would likely require additional benefit expenditures, and thus higher tax revenues to finance them. By taxing the BI alongside other incomes, its net value would fall for those in higher tax brackets, reducing its cost and making it more targeted to lower-income groups, who pay lower tax rates. Assuming, of course, fiscal neutrality. My reference to “current institutional arrangements” in the Introduction relates to this point. Most proponents of BIG [basic income guarantee] adopt neo-liberal macroeconomic conceptions of the fiscal capacity of the government and thus fall into believing that there are financial constraints on government spending that can only be relieved with higher taxation or increased debt issuance. Of course, those who understand Modern Monetary Theory (MMT) know, intrinsically, that a sovereign government is never revenue constrained because it is the monopoly issuer of the currency. In that case, it could simple increase its net spending (fiscal deficit) to facilitate the introduction of a BIG. But, in that situation, there are new problems as I will explain. Staying within the OECD’s neo-liberal frame, it notes that benefit systems and tax-free thresholds vary across countries, which means that a simple statement of who would win and who would lose by replacing benefits with a BIG is difficult to make. In terms of their “revenue-neutral BI, adjusted amount” model, they note that (setting the BI = existing GMI levels in the income support systems for Finland, Italy, France and the UK): 1. “In each of the four countries considered here, the largest average gains from a BI would occur among the lowest-income households … This arises as those who are not covered by social protection in existing systems for whatever reason (not having sufficient past contributions to qualify or non-take-up of benefits) and who hence have the lowest incomes would gain from the introduction of a universal BI.” 2. “The richest income group would lose overall in each country too” for various reasons pertaining to each country. 3. “in many cases those in work would see the amount they receive from the BI offset by higher income taxes as tax-free amounts were abolished. This is the case in Finland, the UK and the USA for example”. 4. “In France, those on higher incomes would actually lose between 5% and 10% of their income as the value of the zero- tax band is greater than the BI amount at these income levels, but those with lower earnings would gain.” 5. “In many other countries, however, a single person without children would see (often quite substantial) gains at all income levels … In these countries, gains generally increase with earnings for lower earnings ranges: the BI would not be means tested away, and peak at the point where entitlement to existing means-tested support expires.” 6. “Gains remain substantial in Japan and the Netherlands, however, as the BI amount still exceed additional tax payments made even at relatively high earnings levels.” 7. In Italy, “introducing a BI would involve very large percentage changes in incomes at low earnings levels, but … changes are small for those with higher income levels.” 8. “In Finland, France and Italy, large losses would occur among those who receive unemployment insurance benefits or early retirement pensions … The pattern in the UK is different: as the revenue-neutral BI amount is lower than the value of GMI benefits, lower-income groups often lose.” 8. “The extent of gains … suggests that replacing existing social protection systems with a BI along the lines described here would not be budget-neutral.” They provided Figure 4 to show the distributional consequences of a BIG (winners and losers by decile). The explanation for the patterns is complex and arises from the differences in the structure of tax and welfare systems in each country. I will leave it to you to examine each nation’s results if you are interested in more detail. The other approach they analysed was a “revenue-neutral BI, adjusted tax rates” – in other words, a higher BIG matched with revenue from varying taxes (up or down – depending on the current situation). They note that setting the BI = existing GMI levels in the income support systems: 1. “In Finland and France, this is little different from the previous variant” given the nature of the existing support structures. 2. “In Italy, this variant involves a big reduction in income taxes, which significantly benefits richer households but does little to increase the incomes of many poorer households”. 3. “The opposite is the case in the UK.” The poor and the middle income groups see no change but the highest income groups “would lose significantly”. The OECD Figure 7 (reproduced next) shows the winners and losers in detail across the income distribution. The columns show the shifts (up and down) from BIG, tax rises and benefit losses. The diamonds show the net result in absolute terms. The loss of benefits and increased tax burdens typically offset (or nearly) the benefits of the BIG for many cohorts. In both models, the OECD provide more detailed results of the winners and losers by family size and structure and age breakdowns. But the aim of the exercise was to establish the impact of the BIG on poverty? The OECD conclude that: 1. “Although there would be more winners than losers among low-income groups under a BI [basic income]… it would not prove to be an effective tool for reducing poverty”. 2. “In Finland and France, relatively good benefit coverage among poorer households means that poverty would be higher under both BI variants considered here as, despite benefit spending being much higher with a BI, it would be much less well targeted.” 3. “Even in Italy, where existing benefit spending is not well targeted on poorer households, poverty would be roughly the same in the case where existing spending was used to give everyone a BI rather than targeted on specific groups.” 4. “In the UK, the revenue-neutral BI amount is significantly below the level of existing GMI benefits, so it is perhaps unsurprising that this leads to much higher levels of poverty. However, even in the case where taxes are raised significantly to pay for a BI at the level of GMI benefits, the BI does not significantly reduce poverty.” 5. “Rather than reducing the overall headcount of those in poverty, a BI would change the composition of the income-poor population … In all countries, a reduction in poverty among those currently not covered by social protection systems would be offset by some of those who are covered by existing social protection systems and who lose out from the introduction of a BI moving into poverty.” So there you have it. A BIG as is typically proposed is not a magic cure for poverty. Under fiscal neutrality, the maximum sustainable BIG would be modest. Aggregate demand and employment impacts would be small, and even with some redistribution of working hours; high levels of labour underutilisation would persist. Overall this strategy does not enhance the rights of the most disadvantaged, nor does it provide work for those who desire it. It is obvious that persistent unemployment could easily be avoided by the introduction of the BIG if it was accompanied by a net government stimulus (deficit). This recognises that at all times, given the spending and saving decisions of the non-government sector, the existing unemployment level is the choice of the currency-issuing government – in other words, mass unemployment means that the deficit is too small relative to non-government saving desires. Without an appropriate fiscal stimulus, the basic income proposal would achieve full employment by persuading the unemployed to drop out of the labour force upon receipt of an income guarantee. The economy would move towards full employment by stealth – pushing workers out of the labour force rather than providing work for them. But the value of the currency would then fall given that nothing is provided in return for the government spending. The resulting inflationary bias would invoke interest rate adjustments (given the current inflation-first approach adopted by central banks) that would constrain the economy from achieving sufficient growth to offer real employment options to all aspiring workers. But then a further quandary emerges. The more generous BIG [basic income guarantees], would probably stimulate total spending such that there would be a shortage of labour at ‘full employment’, resulting from the artificial reduction of the full employment level of employment, which then compounds the inflationary pressure. The alternative is that the excess demand for goods would be increasingly met via imports with consequential effects for the exchange rate and the domestic price level, which would accentuate the inflationary pressure. Thus the introduction of a BIG [basic income guarantee] policy is likely to be highly problematic with respect its capacity to deliver both sustained full employment and price stability. A sound policy also has to be viable if the extremes of that policy are encountered. It is obvious that the basic income proposal does not satisfy that requirement. As more an more individuals opted for the basic income without work, output would drop dramatically and material prosperity would be violated. Leisure and consumption are closely related. Further, given the logic employed by the basic income proponents that the government providing the basic income is financially constrained, the logic means that as increasing numbers of workers ‘liberated’ themselves by taking the basic income, the capacity of the government to sustain it would diminish. In other words, on its own grounds, the basic income proposal is limited in scope. What about an MMT-style BIG? That is, one that recognises that the government would have no need to increase taxes to facilitate the introduction of the BIG. If there is mass unemployment, then the solution is for the government to expand its net fiscal impact (spending over taxation) and allow the deficit to rise. So shifting from a state of mass unemployment to the introduction of a basic income guarantee would require a net government stimulus (that is, an increasing fiscal deficit). In this regard, the basic income guarantee (funded by an increasing fiscal deficit) constitutes an indiscriminate Keynesian expansion and as it lacks any inbuilt price stabilisation mechanisms, inflationary pressures would result. Workers who draw income from the production cycle have also added output (via their labour) to that cycle. For a given level of productivity (output per unit of input), the more people that have access to income, spend that income at market prices, but do not add to output (that is, are supported in real terms by the production of others), the greater the inflation risk. Further, the greater the share of income generated in any period that is received by people who offer nothing in return, the higher the inflation risk. Under these circumstances, the more people pursue the ‘freedom’ on non-work under the basic income guarantee, the worse the situation becomes because for given productivity, this would mean the supply side of the economy keeps shrinking, while the demand side remains stable (depending on the level of the stipend). So we come back to the point that to minimise the inflation risk, the basic income stipend has to be small, which then, in turn, means the scheme hardly addresses the dignity of an independent existence. People have income security but are in poverty. We can explore this vulnerability further. If the government increases net spending (its deficit) to fund a generous basic income stipend then the demand for labour rises in response to the higher aggregate spending in the economy. Clearly, labour demand would higher than under a fiscally-neutral introduction of a basic income guarantee. The real issue is what happens to labour supply. If the stimulus was wrought via the payment of a generous basic income stipend, then it is reasonable to surmise that total labour supply would decrease. In other words, the level of employment that coincides with ‘full employment’ where everybody who wants a job can find one is artificially reduced in the presence of the basic income guarantee (if sufficiently generous). The real resource space available for the stimulus is thus reduced. The more people who took the stipend and withdrew from the labour force, the less real capacity there would be in the economy to respond to nominal spending growth. With less productive workers available, the stimulus would cause what economists call ‘demand-pull’ inflation. The inflation rate is pulled up by an incompatibility of nominal spending relative to productive capacity. Firms would compete for increasingly fewer workers and drive up wages, which would have the consequence of making the basic income stipend less attractive at the margin. Some ‘Malibu surfers’ might decide to resume work again. The government might respond by raising taxes and/or reducing government expenditure, which would tend to raise unemployment. The central bank, under the current regime that governs monetary policy, would also respond by raising interest rates. The combination of these policy responses would reduce the demand pressure, but to the extent that the inflationary process had assumed a cost-push form (distributional struggle over available real income), wage and price inflation may only decline slowly. It is thus possible that an unsustainable dynamic could be generated in which there are periodic phases of demand-pull inflation and induced cost-push inflation at low rates of unemployment, followed by contractionary policy and high rates of unemployment. These economic outcomes are consistent with indiscriminate (generalised) Keynesian policy expansions of the past. Our conclusion is that the introduction of a basic income guarantee which is designed to also sustain full employment (that is, to give all those who want to work the opportunity) is likely to be highly problematic given the likely inflationary consequences.

Frederic Mishkin is correct that the Federal Reserve must not imitate Paul Volcker’s mistake of easing monetary policy before inflation is defeated ( Opinion, September 15). President Joe Biden must also avoid Ronald Reagan’s mistake of running stimulative fiscal policy while the Fed is fighting inflation. In the 1980s, US deficits reached 5 per cent of gross domestic product. To offset this stimulus, the Fed was forced to raise rates to what Helmut Schmidt observed were their highest levels since the time of Christ. The combination multiplied government debt. Contractionary monetary policy and expansionary fiscal policy contributed to US current account deficits approaching 3 per cent of GDP. As the Fed seeks to reduce aggregate demand, as US Treasury rates have increased by hundreds of basis points since the start of 2022, and as the US current account reached 4.8 per cent of GDP in the first quarter of 2022, fiscal discipline is again essential.

The spending power of older Americans, bolstered by Social Security benefits, is a potent financial force. Businesses offer senior discounts to entice retirees, who tend to spend more of their money than other age groups. When Social Security beneficiaries help local businesses to prosper, those businesses hire additional workers and order more supplies, infusing the economy with even more money. Thanks to this ‘multiplier effect,’ every dollar paid in Social Security benefits produces $2 in stimulus to the economy. That adds up to more than $1.6 trillion dollars in national economic stimulus annually. Social Security benefits are responsible for sustaining some 10 million jobs, including roughly $400 billion in salaries and wages. With figures like these, even Wall Street must acknowledge that Social Security is incredibly good for Main Street. “Seniors are really important to local businesses,” says Abraham Kapusuz, former managing partner of a New Jersey restaurant that thrives on an older customer base. “During the early bird special, at least 80% of the customers are seniors. Most of their income is from Social Security. They contribute to the business – and the economy – bigtime.” But the opposite is also true. If Social Security benefits are cut, seniors will have less income to spend on goods and services – which is bad for Main Street. “If the government cuts Social Security benefits, it would affect the bottom line tremendously,” says Kapusuz. “Now you have to start laying off employees, which has a chain reaction throughout the local economy.” The National Committee to Preserve Social Security and Medicare has compiled fresh data on the economic impact of Social Security on congressional districts in all 50 states and U.S. territories. Most Americans would be surprised at how much money flows into their communities from those monthly Social Security checks, including red and purple states represented by aspiring benefit-cutters in Congress: In Florida, Social Security injects $70 billion into the state’s economy every year in the form of benefit checks to 4,532,000 retirees, disabled workers, survivors and children. Texas receives a $61 billion annual cash infusion through payments to 4,126,000 beneficiaries. 2.3 million Ohioans receive a total of $35 billion in Social Security benefits each year. It’s ironic that conservatives who purport to believe in ‘fiscal responsibility’ and a strong economy do not appreciate – or willfully ignore – these figures. Instead, they blew a $2 trillion hole in the federal debt with the Trump/GOP tax scheme (which has not trickled down to working people) and propose to cut Americans’ earned benefits to close the gap. If anything, this is the height of fiscal irresponsibility. The economic engine of Social Security is already humming. Why choke it with benefit cuts? The political right would like to use not only the Trump/GOP tax cuts, but projections about the program’s long-term finances, to cut Social Security. While it’s true that the Social Security trust fund will be able to pay roughly 80% of benefits after 2034 if Congress takes no action, legislation has already been introduced that would keep the program financially sound for the rest of the century while modestly boosting benefits, mainly by asking the wealthy to pay their fair share. In fact, the authors of two of those bills, Senator Bernie Sanders (I-VT) and Rep. John Larson (D-CT) have just launched “Expand Social Security” caucuses in the House and Senate, along with Senator Elizabeth Warren (D-MA) and other key members of Congress. The formation of these caucuses crystallizes the efforts of Social Security advocates and lawmakers to put more – not less – much-needed income into the hands of America’s seniors. This means not only boosting monthly benefits, but adopting a more accurate consumer price index for the elderly (CPI-E) and increasing the minimum benefit formula – all of which will provide even greater economic stimulus.

The Phillips curve captures the empirical inverse relationship between the level of inflation and unemployment. The reciprocal of its slope, sometimes referred to as the “sacrifice ratio,” represents the increase in the unemployment rate associated with a 1 percentage point reduction in the inflation rate. In this Chicago Fed Letter, we provide evidence that the Phillips curve has steepened in many industrialized countries since the start of the recovery from the Covid-19 pandemic. This suggests a lower sacrifice ratio now than before 2020.1 The gist of our main result is apparent in figure 1, which shows the Phillips curves of the United States, United Kingdom, and France during two time periods: the seven years (or 28 quarters) before the pandemic (2013:Q1–2019:Q4) and the six quarters of the recovery for which we have data (2021:Q1–2022:Q2).2 These three countries’ Phillips curves have steepened significantly during the recovery, in stark contrast with their flat Phillips curves of the pre-pandemic period. Before the pandemic, the U.S. Phillips curve had been flattening for over a decade and was considered “dead” by many economists.4 It appears this pattern has sharply reversed over the first six quarters following 2020.

In the rest of this article, we show that Phillips curves have steepened across a sample of 29 industrialized countries using data from the Organisation for Economic Co-operation and Development (OECD).5 This change in the relationship between unemployment and inflation is robust to the inclusion of crude oil prices, inflation expectations, and other measures of economic slack besides the unemployment gap.6 What drives our results is that declines in unemployment rates are associated with larger increases in inflation rates during the recovery from the pandemic than during the pre-pandemic period. Our results are generally the same when we examine countries individually (within-country variation) or when we study them pooled together (cross-country variation).

At a press conference following the Fed’s Open Market Committee meeting on June 14, 2017, Janet Yellen remarked: “We continue to feel that, with a strong labor market and a labor market that’s continuing to strengthen, the conditions are in place for inflation to move up” (Yellen 2017). Likewise, Fed Chairman Jerome Powell believes the Phillips curve “continues to be meaningful for monetary policy” even though the strength of the relationship between unemployment and inflation “has weakened” (Powell 2018).6 A few years earlier, in 2015, then president of the Federal Reserve Bank of Atlanta, Dennis Lockhart, in an interview with the Wall Street Journal, stated: I think a policymaker has to act on the view that the basic relationship in the Phillips curve between inflation and [un]employment will assert itself in a reasonable period of time as the economy tightens up, as the resource picture in the economy tightens. I am quite confident that that basic expectation will materialize.… I don’t know if I would quite say that I am resting everything on a model, but I am certainty prepared to get comfortable based on [an] expectation that seems to me to have compelling logic [Hilsenrath 2015, interview with Lockhart]. A final example of how the Phillips curve continues to be treated by Fed officials as a useful guide to policy, even in the face of strong evidence during the last 20 years that the degree of unemployment is a poor indicator of inflation, comes from a working paper prepared by the staff of the Federal Reserve Board’s Divisions of Research & Statistics and Monetary Affairs in 2018: While inflation appears to be insensitive to labor market slack, policy needs to take proper account of the prospects for persistently tight labor markets leading to higher inflation, or other imbalances, that could eventually endanger prospects on the employment side of [the Fed’s] policy mandate [Erceg et al. 2018: 18]. All of the forgoing examples show that central bankers are not yet willing to discard the Phillips curve as a policy tool, even though the evidence for a downward sloping curve is meager. Indeed, as early as 2002, William Niskanen, a former member of President Ronald Reagan’s Council of Economic Advisers, declared: “The concept of a Phillips curve should be considered empty when most of the variation in the data must be explained by shifts in this presumed relation. In any case, the Phillips curve proved to be a poor basis for forecasting and a worse guide to policy” (Niskanen 2002: 194).

The Federal Reserve’s Dual Mandate is the Phillips Curve. It’s not that the Fed is charged with the impossible task of reaching a state of 2% inflation and full employment; rather, the Fed is trying to obtain these two goals, believing (according to the Phillips Curve), these goals come as a trade-off needing to be managed. Just two weeks ago, Chair Powell spoke of this on-going battle, like a never-ending tug of war between inflation and employment, as reported by Reuters: We have to balance those two goals when they are in tension, as they are right now. This tension, as described by Powell, is not just another Powell-ism, or something the head of America’s central bank said off the cuff in an interview. Instead, this idea of balancing inflation against employment has been a widely discussed phenomena in academia and by central bankers for several generations. The current CEO of the Federal Reserve Bank of New York, a man who may be more powerful than Powell himself, co-authored a paper in 2014 explaining the trade-off, calling it the “divine coincidence of monetary policy,” whereby: …the central bank can simultaneously stabilize both employment and inflation by altering a single policy instrument—the short-term nominal interest rate. According to one of the current members of the inner circle at the Fed, just by changing interest rates, employment and inflation will simultaneously stabilize. The above quotes are only two examples. But countless instances exist where economic planners discuss the necessity of balancing the two objectives, as if it’s a zero-sum game.

The idea that the government would commit itself to act as an employer of last resort and guarantee a job to everyone has been getting more attention in recent months. While many on the left have long pushed this position, the Clinton-linked Center for American Progress (CAP) recently embraced the idea in a conference last week. It is good to see ideas outside of the mainstream getting attention, but there are a couple of issues worth keeping in mind to ensure that the effort does not end up being counterproductive. The first is to recognize that a job guarantee is a huge lift, not only politically but in its implementation. In effect the guarantee is not only going to be providing jobs to workers who do not currently have one, but it will also end up offering a potentially more attractive alternative to millions of people now in low-wage jobs. How attractive the alternative is will of course depend on the wage offered in the government supported jobs. The number tossed around for a wage by the CAP folks was $15 an hour. In the current economy, this would be higher than the wages of 30 percent of men and more than 40 percent of women workers. That is more than 50 million workers. Presumably this $15 an hour wage is some number of years in the future and likely associated with a sharp increase in the minimum wage, but we would still likely be looking at a situation where the federal government would be overseeing the employment of well over 10 million people under this program. By comparison, the federal government now directly employs 2.2 million people, not counting the Postal Service. Is it reasonable to believe that the federal government could effectively oversee the employment of a workforce that is more than five times its current level? That seems like a serious leap. And, there will be political consequences to doing this poorly. If the government puts in place a jobs guarantee and a substantial number of people turn out to game the system, either directly as workers who don’t work or as intermediaries who list phony workers, it is not likely to be long for the world. During the Obama years some of us were pushing for what seemed a much smaller lift: a youth jobs program for people in areas of high unemployment. There was little interest. While I never got a clear explanation of the downsides to such a program, I always assumed that the fear was that Fox News would get pictures of two kids enrolled in the program sitting on a park bench drinking beer. Not wanting to deal with the fallout from this potential risk, the Obama administration chose not to go this route. Clearly the risks of abuse with a full-scale job guarantee would be several orders of magnitude larger. This is why when Jared Bernstein and I discussed this issue in our book on Full Employment, we recommended trial programs. If we show that this can be done effectively, it will be possible both administratively and politically to expand the program. There is another aspect to this sudden interest in this political long shot, which is a huge potential downside. The Federal Reserve Board is currently in the process of raising interest rates with the idea of limiting the number of jobs in the economy. The Fed’s ostensible concern is that the labor market is getting too tight, which will lead to more rapid wage growth, which will lead to higher inflation. There is a campaign organized by the Center for Popular Democracy to push back against the Fed’s plans to keep hiking interest rates. While it is great to talk about what the government could potentially do to help workers, the most immediate issue is to not have it do things to hurt workers, like having the Fed raise interest rates to reduce the rate of job creation. If progressives’ focus on the aspiration of a job guarantee causes them to ignore the Fed’s interest rate hikes occurring in front of our faces, it will be a serious loss.

This afternoon, the Federal Reserve will announce what it's doing with interest rates. These regular announcements are part of the central bank's sweeping role as the American economy's Great Balancer: eternally choosing how many jobs to create or destroy in exchange for higher or lower inflation. But this almost God-like mission would be completely remade if some ambitious Senate Democrats get their way. I'm referring to a national job guarantee. It's basically a public option for employment: The government would set up a system to track the work that local communities and groups need done, and then everyone who wants work can come and get matched to a job in their area. The government would pay everyone working for the program $15 an hour, plus health benefits. The idea is to drive unemployment as low as it can possibly go, especially for marginalized groups, and keep it there. The job guarantee would also create a floor for pay and benefits that the entire economy would have to meet or exceed. Sen. Cory Booker (D-N.J.) already has legislation that would test run the idea in 15 localities around the country, presumably as a prelude to eventually going national. Sens. Kirsten Gillibrand (D-N.Y.), Jeff Merkley (D-Ore.), Elizabeth Warren (D-Mass.), and Kamala Harris (D-Calif.) are co-sponsors. Meanwhile, Sen. Bernie Sanders (I-Vt.) is working on a separate bill that would create a national version right away. What does all this have to do with the Federal Reserve? Like I said, Congress has given the central bank a two-part job: maximize employment and keep prices low and stable. By cutting interest rates, the Fed accelerates job creation, but also potentially accelerates inflation as well. By hiking interest rates, as it's done recently, the Fed applies the brakes to both. This requires an eternal balance between the two priorities. But the issue goes deeper: Right now, the Fed assumes that if unemployment gets too low, inflation will rise unsustainably. The theory is that as jobless Americans become scarce, businesses have to attract already-employed workers to keep expanding. That sets off a bidding war between employers that drives wages up and up, and eventually forces the prices of goods up as well. And we get inflation. As Steve Goldstein pointedly put it, the Fed's mission is to guarantee that everyone doesn't have a job. Of course, that also means a job guarantee would instantly make the Fed a more benign force in the economy. The central bank would no longer move people from employment to unemployment when it hiked interest rates. It would simply move them from private sector employment to job guarantee employment. (This point is made repeatedly by pro-job guarantee economists.) It would also allow the Fed to concentrate on keeping prices low and stable — a change that, ironically enough, right-wing inflation hawks might appreciate. But by taking unemployment out of the Fed's control, we would also upend the conceptual framework it currently relies on. The central bank would have to come up with a whole new strategy, and a whole new set of principles, for when and how to adjust interest rates. The job guarantee would also create millions of new public employees — something conservatives definitely would not appreciate. This might force them to accept higher inflation levels, lest they expand a "nationalized" labor force. On the other hand, they might deliberately try to drive interest rates way up, and flood the program with more workers than it can handle. Then there's the question of how inflation itself would react. Experts who support the job guarantee argue it's not designed to compete with private employers for labor. During recessions, when private businesses lay people off, the size and spending of the job guarantee would naturally expand. That would also stimulate the rest of the economy back to health. As the private sector recovered, it would offer more jobs, outbidding the job guarantee's $15-an-hour floor. That would draw workers back into private employment, and the program's size and spending should shrink. As a result, job guarantee supporters argue the program will hit the economy's sweet spot: Maximizing employment without setting off a perpetual wage-price spiral. Sustained low unemployment will probably juice productivity rates as well, which should also lessen inflationary pressure. Making $15-an-hour the new minimum for the whole economy would likely force a one-time adjustment in wages across the income spectrum. That could lead to a temporary burst of inflation, at least. (Happily, the more private businesses adjust wages to meet that floor, the more workers they'll hold onto, and the more manageable the job guarantee's employment numbers are.) A job guarantee program would likely need some workers with prior experience in a host of fields, to mentor new workers and help them learn on the job. That may require at least some wage bidding wars with private employers. One group of economists also recommended building a wage scale into the job guarantee — i.e. make it possible for workers to get promotions. That would be a good non-punitive incentive for people to work hard and take job guarantee employment seriously. And it wouldn't necessarily lead to bidding wars over workers. (Private businesses promote workers to incentivize them as well, even when they're not looking to expand.) But it's a potential complicating factor. We've just never tried a policy like this before. We don't quite know how it will play out. It would be helpful to prepare the Fed for that, and keep its control over interest rates as a backstop. The simplest fix is probably just changing the Fed's mission: from maximizing employment and stabilizing inflation, to minimizing job guarantee employment and stabilizing inflation. Point being, Congress gave the Fed its current mandate, and it can give the Fed a new one. Should a job guarantee ever pass, the Fed will need the update.

There has been a surge of interest in the last year in the idea of a government job guarantee. A number of economists associated with the Levy Institute at Bard College and University of Missouri at Kansas City have long pushed the idea. In recent months, several potential candidates for the 2020 Democratic presidential nomination have publicly raised the idea, including senators Cory Booker and Kirsten Gillibrand, and of course Bernie Sanders, who has fully endorsed it. While the idea of guaranteeing a decent paying job to every worker who wants one is appealing, it is likely to prove a difficult lift in implementation. A guaranteed job would radically transform the labor market in a way that could put tens of millions of workers on the public payroll. This would almost certainly put many low-wage employers out of business and raise the costs to consumers of services like restaurants, haircuts, and house cleaning. It also effectively gives the government direct responsibility for allocating workers across regions. The basic issue is that the program is designed to guarantee all people decent pay through their work. The problem is that this guarantee will not only provide an opportunity to those currently unemployed or under-employed; it would provide a better option for tens of millions of workers who already have jobs. A key issue here is determining the number of people who might opt for this public program. That will depend on the wage rate. In the plan being pushed by the Levy Institute (politically, most closely associated with Sanders), the wage rate is $15 an hour. This is around the 25th percentile of the wage distribution, meaning that 25 percent of the workforce, or roughly 40 million workers, now gets less. The proposal also calls for health-care insurance equivalent to that received by federal employees. This would make the plan attractive to even more low-wage workers, most of whom do not get employer-provided health-care benefits. In addition, government jobs are likely to offer job security and protection against abuses by an employer, like sexual harassment, which is yet another reason why they may prove attractive to workers in the private sector. Given the number of workers who currently are paid less than the $15 an hour proposed wage, plus health care benefits that are worth at least $4 an hour, it might be that 10 million workers would leave private sector jobs for a guaranteed federal job. And that’s a conservative estimate; it could quite possibly be more than 20 million. With 10 million or so unemployed and underemployed workers, we are likely talking about having at least 20 million people in the program and perhaps over 30 million. Currently the federal workforce, excluding the Postal Service. is 2.2 million, so this is increasing the number of workers employed by the federal government by a factor of at least ten. The proposal calls for the program to be administered at the state and local level. This also presents issues (many of these governments have serious corruption problems), but even using state and local employment as a denominator, we would still be talking about doubling current levels. It requires some serious faith in government to think that this sort of leap in employment levels can be well-managed if done in a short period of time. It doesn’t help that many of these workers will have little education and job experience. There is also the issue of what happens in the private sector. The opportunity to get a public-sector job, with health-care insurance, paying $15 an hour, effectively imposes a floor on wages in the private sector. If we say that 50 million people now earn less than this package (the median wage is around $23 an hour – 80 million workers earn less), and the average gap is $4 an hour, then the additional cost to matching this wage in the private sector will be roughly $350 billion a year (this calculation assumes 1750 hours per worker and 50 million workers). That sum comes to roughly 1.8 percent of GDP. There also has to be some spillover effect. Workers who had been earning $16 or $17 an hour will have to see some bump in pay when the pay for those at the bottom jumps to $15 from levels that are currently as low as $7.25 an hour. If 20 million workers are in the bump range, and they get an average pay increase of $2 an hour, that raises the cost by another $70 billion, putting the total at $420 billion, or 2.1 percent of GDP. And this brings us to inflation. As a first approximation, this 2.1 percent figure would be the impact on the level of prices, although it would be dampened by reduced profit margins and increases in productivity. In any case, a Federal Reserve Board committed to a 2.0 percent inflation target would send interest rates soaring in response to this rise. But even if the Fed can be controlled, this rise in pay for those at the bottom will mean a reduction in living standards for those higher up. They will have to pay more for restaurants and haircuts, as well having their house cleaned and their lawn mowed. Most of us won’t shed any tears for the “hard to get good help” crowd, but if we haven’t taken steps to weaken their economic power—which won’t be easy because they are powerful—we can expect to see doctors, lawyers, and other high-end earners getting pay hikes to protect their living standards. This is a story of serious wage-price spiral, unless we introduce other measures.

Consider a GND [Green New Deal] to be financed through a fully anticipated inflation, constituting a tax on non-interest-bearing money. Assume also that all money except currency earns interest. Currency in circulation is about $1.7 trillion.129 If we assume, conservatively, that a GND financed with money creation would result in an anticipated inflation of 10 percent per year, then the implicit tax on currency, yielding a transfer of real resources to the government, would be about $170 billion per year. Note that this tax is less than the cost to the economy inflicted by the inflation, as individuals and businesses take actions to protect themselves from this tax. This is another dimension of the excess burden attendant upon governmental acquisition of real resources; estimates of this effect vary, but one survey of the literature finds: A number of empirical studies have sought to measure the interactions between inflation and the nominal nature of the U.S. tax system. Most find the costs are large. Authors James Bullard and Steven Russell, for example, suggest approximately a 1 percent output loss for each 1 percent increase in inflation above price stability.130 This inflationary version of the excess burden created by the government acquisition of resources would take the form of such adverse consequences as a degradation of the currency as a store of value, adverse behavioral responses by holders of currency, and the like. The use of money creation to service debt incurred to finance the GND also is deeply dubious, as any such approach would be based on an assumption that purchasers of government debt instruments will deliver real resources to the government with no expectation of receiving repayment in an equivalent amount of real resources, plus interest. It cannot be the case that lenders to the government are so myopic.

When advocates of a Green New Deal are asked how the U.S. can afford its lavish promises of 100% renewable energy, millions of high-paid jobs and Medicare for all, they have a ready reply. "We will pay for the Green New Deal the same way we paid for the original New Deal, World War II, the 2008 bank bailout, extended quantitative easing programs, all our current wars," said a blog post that appeared earlier this month on the website of Rep. Alexandria Ocasio-Cortez (D., N.Y.). "The Federal Reserve can extend credit to power these projects." The Fed extending credit is a euphemism for printing money. To critics, it sounds like a guarantee for inflation. Not necessarily: the Fed prints money all the time without creating inflation. The problem is that once you work through the mechanics, it doesn't save any money. At the end of the day, the Green New Deal will face the same constraints that all such undertakings do: They can't spend more than the economy can produce. Ignoring those constraints will either lead to inflation, a politically weakened Fed, or both. By law, the Fed can buy any obligation issued by the Treasury or a federal agency such as Ginnie Mae. From the end of 2008 through 2015, the Fed, via quantitative easing, bought nearly $4 trillion of Treasurys and securities backed by mortgage agencies Fannie Mae and Freddie Mac, which Treasury took over in 2008. So the Fed could certainly buy federally-guaranteed Green New Deal bonds, provided doing so helped it reach its own monetary-policy goals. Quantitative easing, for example, was designed to pull down long-term interest rates, thereby propping up growth and staving off deflation—not to help the federal government borrow. Similarly, the Fed lent to banks and other financial companies during the 2008 crisis as their lender of last resort. To be sure, it stretched the boundaries of that authority, but it didn't need any prodding; the alternative, Fed officials figured, was a complete collapse of the financial system. There have been times, though, when the Fed subordinated its usual goals to help the Treasury. During World War I, it kept interest rates low and lent to private banks to ease the sale of war bonds. During World War II, it agreed to cap Treasury yields and buy debt to support the war effort. On both occasions, wartime spending pressures fueled inflation that the Fed had to beat back after peace returned. Sarah Binder, a political scientist at the George Washington University who has studied the Fed, says the episode most relevant to the present was Congress' decision in 1966 to authorize the Fed to buy federal-agency debt for the purposes of supporting the housing market. In Congressional hearings, "the Fed was vocal about not wanting to make those purchases." It saw them, she said, as "choosing winners and losers and crossing the boundaries into fiscal policy." Suppose a future president or Congress similarly pressures the Fed to buy Green New Deal debt. Since the Fed would ultimately return any interest it earns on such bonds to the Treasury, this might sound like a big money-saver. But it isn't. To buy a Green New Deal bond, it wouldn't buy an equivalent amount of Treasury bonds, so the net savings would be effectively zero. To absorb the extra Treasury debt, investors might have to charge other borrowers more, potentially "crowding out" private investment. What if it bought the bonds by printing money, as quantitative easing involved? As a practical matter, the Fed doesn't literally print new currency, it electronically creates reserves—money that commercial banks keep on deposit at the Fed. If it did so when the economy was depressed, then interest rates would already be zero and the Green New Deal debt could be sold to private investors almost as cheaply. If the Fed bought the bonds in normal times, when interest rates are above zero, it would have to pay interest on the reserves it issues to banks, offsetting the income earned on the bonds, as it has done since 2015. Indeed, between 2014 and 2018, its remittances to Treasury fell by a third. So the Fed can't make a Green New Deal cheaper without compromising its control of interest rates and thus inflation. Green New Deal advocates think inflation risks are exaggerated. A massive increase in the deficit, whether financed by the Fed or private investors, could create many millions of jobs without exceeding the economy's productive capacity, they say. It isn't impossible—unemployment has already fallen lower and employment grown faster than many economists thought possible without triggering inflation. But to run up the deficit on a bet those trends can go considerably further looks unnecessary and risky. Unnecessary because the Fed is already probing how low unemployment can drop without spurring inflation. Risky because if inflation does take off, so will interest rates, and all that Green New Deal debt will start to snowball.

Because the private market has no incentive to reduce carbon emissions, the government intervention is necessary. But not all interventions are created equal, and the Green New Deal’s seem engineered to be as expensive as possible. Consider its goal of massive public investment to achieve 100% renewable energy in as little as 10 years. Kevin Book, head of research at ClearView Energy Partners, a research firm, estimates replacing the 84% of current U.S. generation that is not renewable with solar photovoltaic, wind and biomass would cost $2.9 trillion - nearly a full year’s tax revenue. This excludes a cost for interest, operations, maintenance, new transmission lines or compensation to private investors for writing off natural-gas and coal plants with plenty of useful life left. It assumes cheap batter storage that doesn’t yet exist. Even so, this works out to $83 to avoid one metric ton of carbon dioxide. The Green New Deal’s plan to upgrade every building in the U.S. to “maximum energy efficiency” is even more questionable. A study by Meredith Fowlie, Michael Greenstone and Catherine Wolfram in the Quarterly Journal of Economics found the federal government paid an average of $4,585 each to weatherize homes in Michigan. Extrapolate that to 95 million homes nationwide, and the bill tops $400 billion. The cost of avoided carbon dioxide: up to $285 per ton. To understand how high $84 to $285 per ton of carbon dioxide is, consider that Barack Obama’s economists put the economic harm of a ton of C02 at $50. Or that you can pay a power producer just $6 to reduce emissions by one ton in New England, $15 in California, and $25 in the European Union, based on emissions permit prices in those jurisdictions, notes Mr. Greenstone, an economist at the University of Chicago. Yet in the Green New Deal, trillion-dollar price tags are a feature, not a bug. That is because its mission is to create “millions of good, high-wage jobs” in “front-line and vulnerable communities.” The higher the price tag, the more jobs it creates. How to pay for it? Its Democratic sponsors would raise taxes on the rich and borrow the rest, including from the Federal Reserve, just as the U.S. did during World War II, dramatically boosting output and employment. But in 1941, the U.S. had plenty of unused resources to mobilize: just 28% of prime-aged women had jobs. By 1945, 35% did and today, 74% do. (The data aren’t strictly comparable due to changing definitions). The war effort still spurred intensive inflation pressure, contained only with wage and price controls. The U.S. is now close to full employment and its debts are far higher. Even in today’s world of low inflation and low interest rates, the scale of deficit spending the Green New Deal implies would likely push both higher.

“The Fiscal Theory of the Price Level” is the title of Mr. Cochrane’s next book, to be published in the fall. It’s a challenge to monetarism, the theory of controlling money as the chief method of stabilizing the economy. The new theory holds that when the overall amount of government debt is more than people expect the government to repay, we see inflation. The price of everything goes up, and the value of the dollar declines. How does this work? “The U.S. government has $20 trillion of debt outstanding,” Mr. Cochrane says. “That means, over the long run, people must expect taxes to exceed spending by $20 trillion to repay the debt.” But if they think the government will be able to pay back only $10 trillion in today’s money, “people will try to get rid of their government debt fast, before it is worth less. They try to sell it in order to buy other things,” driving up the price of everything else. “That keeps going until all prices have doubled—until the $20 trillion promise is only worth $10 trillion at today’s prices.”

Fiscal policy has entered a period of normalization, with the priority turning to ensuring a consistent policy mix to deliver price and financial stability and reduce debt vulnerabilities. Fiscal deficits and public debt ratios have fallen since 2020, and inflation surprises have helped the adjustment of public balance sheets in some countries. But relying on inflation to keep reducing debt is not a sustainable approach, as bondholders would demand higher interest rates to compensate for higher and more volatile inflation. Moreover, deficits and debts generally remain above prepandemic levels, which means that additional fiscal efforts will be needed in the years ahead. In the present environment of high inflation, rising interest rates, and elevated debt, it is critical that fiscal and monetary policies are aligned to ensure price and financial stability. In many countries, fiscal policy should tighten to help ease inflation pressures, thereby allowing central banks to raise interest rates by less than otherwise (see Chapter 2). Such fiscal restraint should protect priority areas and manage heightened social demands from the cost-of-living crisis amid a slowdown in economic growth. Even so, spending pressures will need to be contained, as different groups may seek to be compensated for past inflation. Full compensation could make inflation more persistent and require additional monetary and fiscal tightening in the future. An overall fiscal tightening that protects the vulnerable through targeted measures can help countries achieve an appropriate policy mix (see Chapter 2).

Annual inflation in the U.S. rose to 7.5% in January, the highest it’s been since February 1982, when it was 7.6% and declining. This current crisis, economist John Cochrane says, came as “a complete surprise” to the Federal Reserve. “All of the governors who reported forecasts, all of the staff, missed it.” When he calls this an “institutional failure,” he sounds almost kind. Mr. Cochrane, 64, parses the present inflation in a conversation by Zoom from his house in Palo Alto, Calif., near Stanford University, where he’s a senior fellow at the Hoover Institution. His tone is wry, and it’s obvious he doesn’t hold this Fed in the greatest esteem. “They’re leading us in the dark,” he says, “with a great pretense of knowing exactly what the map is in front of us.” He traces the present inflation to the pandemic and the government’s response. Starting in March 2020, “the Treasury issued $3 trillion of new debt, which the Fed quickly bought in return for $3 trillion of new reserves.” The Treasury then sent checks to people and businesses, later borrowing another $2 trillion and sending more checks. Overall federal debt rose nearly 30%. “Is it at all a surprise,” Mr. Cochrane asks, “that a year later inflation breaks out?” He likens this $5 trillion in checks to a “classic parable” of Milton Friedman (1912-2006), the great monetarist at the University of Chicago, where Mr. Cochrane was a professor for 30 years before moving to Stanford in 2015. “Let us suppose now that one day a helicopter flies over this community and drops an additional $1,000 in bills from the sky, which is, of course, hastily collected by members of the community,” Friedman wrote in “The Optimum Quantity of Money” (1969). If they spent the money, inflation would result. The Covid checks, Mr. Cochrane says, were “an immense fiscal helicopter drop. People are spending the money, driving prices up.” Why didn’t the Fed see that this massive stimulus would cause inflation? Mr. Cochrane sees a “big blind spot” in the institution and its “large circle of policy commentators.” The Fed’s “modeling and understanding of ‘supply’ constraints is very simplistic,” he says. It focuses only on unemployment “as a measure of slack in the economy. There is no group of analysts at the Fed measuring how many containers can get through the ports.” More deeply, he says, “the Fed and its larger intellectual circle don’t think about supply at all. All variation in the economy is more or less demand.” This “intellectual failing” showed up first in the recession that followed Covid. “The economy didn’t need demand-side stimulus,” Mr. Cochrane says. “It’s not 1933 again and again. A pandemic is, to the economy, like a huge snowstorm. Sending people money won’t get them out to closed bars, restaurants, airlines and businesses.” The government did have to act “as a sort of insurer, making sure there wasn’t a wave of bankruptcy and helping people really hurt by the recession.” But it should have been obvious that supply constraints would lead to inflation after the recession ended. “The Fed being surprised by supply shocks is as excusable as the Army losing a battle because its leaders are surprised the enemy might attack,” Mr. Cochrane says. He notes that even Lawrence Summers, who served as Bill Clinton’s Treasury secretary and Barack Obama’s director of the National Economic Council, foresaw inflation as early as February 2021 (in a column in the Washington Post). “Summers, who’d argued for big deficits and loose monetary policy to combat low inflation and ‘secular stagnation’ for a decade, saw inflation coming, and saw its source in the massive fiscal stimulus of the Covid recession. So why didn’t the Fed?” I invite Mr. Cochrane to give the current inflation a name to distinguish it from previous episodes. “Naming it sounds like a fun project,” he says. “Our partisan world will likely call it the Biden Inflation, given that it started pretty much on Inauguration Day. But there was a lot of needless stimulus under Trump as well.” The administration may wish to call it the “It’s Not Our Fault Supply-Shock Inflation,” he says. “I’d like to call it the Fiscal Theory of the Price Level Inflation.” “The Fiscal Theory of the Price Level” is the title of Mr. Cochrane’s next book, to be published in the fall. It’s a challenge to monetarism, the theory of controlling money as the chief method of stabilizing the economy. The new theory holds that when the overall amount of government debt is more than people expect the government to repay, we see inflation. The price of everything goes up, and the value of the dollar declines. How does this work? “The U.S. government has $20 trillion of debt outstanding,” Mr. Cochrane says. “That means, over the long run, people must expect taxes to exceed spending by $20 trillion to repay the debt.” But if they think the government will be able to pay back only $10 trillion in today’s money, “people will try to get rid of their government debt fast, before it is worth less. They try to sell it in order to buy other things,” driving up the price of everything else. “That keeps going until all prices have doubled—until the $20 trillion promise is only worth $10 trillion at today’s prices.” Why hasn’t “fiscal inflation” of this kind happened sooner? After all, the government has been borrowing money, as Mr. Cochrane puts it, “like the proverbial sailor”—the drunken one—for decades. “Inflation comes when government debt increases relative to people’s expectations of what government will repay,” Mr. Cochrane says. “If the Treasury borrows but everyone understands it will later raise tax revenues or cut spending to repay the debt, that debt doesn’t cause inflation.” The borrowing and money-printing in 2020-21 was different: “It came without a corresponding increase in expectations that the government would someday raise surpluses by $5 trillion in present value to repay the debt.” The failure of the Democrats’ Build Back Better bill “may augur well for budget seriousness,” Mr. Cochrane allows. But the “troublesome question” remains: “Do people, having decided that at least some of our government’s new debt will not be repaid—leading them to spend it now and inflate it away—also think that the government is less likely to repay its existing debts, or future borrowing? If so, even more inflation can break out seemingly—as always—out of nowhere.” Mr. Cochrane believes that “we overstate the Fed’s power” to respond: “The Fed likes to say it has ‘the tools’ to contain inflation, but never dares to say just what those tools are.” In recent historical experience, “its tool is to replay 1980,” the year when inflation peaked at 14.8%. That means “20% interest rates, a bruising recession that hurts the disadvantaged, with the medicine applied for as long as it takes. Will our Fed really do that? Will our Congress let our Fed do that?” In any case, Mr. Cochrane says, raising rates is a “crude tool to fight inflation, especially when the source is fiscal policy.” He likens the situation to a car going too fast. “Fiscal policy is the accelerator; monetary policy controls the oil. OK, if fiscal policy has floored it, you can slow the car down by draining oil, but that’s not a terribly good way to drive.” Fiscal policy sends checks, stoking inflation; monetary policy raises interest rates to discourage borrowing or encourage savers to hold the extra Treasury debt. To change the analogy slightly, the driver is accelerating and braking at the same time. To overcome inflation, fiscal constraints on monetary policy will need to play a large role, Mr. Cochrane says: “The Fed is merely a copilot.” He notes that in 1980, the ratio of debt to gross domestic product was 25%. Today it is 100% and rising: “Fiscal constraints on monetary policy are four times larger today.” So for a rise in interest rates to lower inflation, “fiscal policy must tighten as well. Without that fiscal cooperation, monetary policy cannot lower inflation.” An additional complication is that any increase in interest rates raises interest costs of servicing the debt. “The government must pay those higher interest costs by raising tax revenues and cutting spending, or by credibly promising to do so in the future.” At 100% debt to GDP, he says, “5% higher interest rates mean an additional deficit of 5% of GDP, or $1 trillion, for every year that high interest rates continue.” This consideration is especially relevant if fiscal policy is at the root of the inflation. “If we’re having an inflation because people don’t believe the government can pay off the deficits it’s running to send people checks, and it will not reform the looming larger entitlement promises, then people won’t believe the government can pay off the additional $1 trillion deficit to pay off interest costs.” Result: “The central bank raises rates to fight inflation, which raises the deficit via interest costs, which only makes inflation worse.” What kind of policy path would it take to stabilize inflation? Mr. Cochrane relies on history as well as theory. “Inflations do not happen to happily growing economies, whose governments run things well and with flush treasuries.” Historically, inflations have always come “to countries in trouble, primarily fiscal trouble, but fiscal trouble caused by bad macroeconomic policies.” When people fundamentally distrust the government to repay debt, interest-rate policies and quantitative easing have limited power. So “the bottom line” is to ensure that people have faith in the government as debtor, and that comes “from solid growth, and transparent, responsible, durable institutions.” There’s no way out without “regulatory reform, tax reform, entitlement reform, as well as clear-eyed monetary policy that works on the narrow things it actually understands.” Mr. Cochrane wants Americans to grasp that ending inflation “isn’t just technocrats at the Federal Reserve fiddling with interest rates.” Healthy economies don’t have inflation “no matter what the central banks do,” while dysfunctional ones have inflation even with “heroic central bank presidents.” Mr. Cochrane calls himself a free-market economist who’s always “trying to find a better phrase than ‘free market’ or ‘supply side’ or ‘neoclassical’ ” to describe himself. He likes the word “incentivist,” because his understanding of economics is “really not so much about markets, but about paying attention to people’s incentives.”

The average primary balance in advanced economies improved by 3.4 percentage points in 2022—for a cumulative improvement of 6.2 percentage points since 2020 (Figure 1.4, panel 1). The cyclically adjusted primary balance in these economies improved by 2.1 percentage points, on average, in 2022 (Figure 1.6). Even so, the average primary deficit as a share of GDP remained about 1.3 percentage points above prepandemic levels. These averages conceal important differences across countries, however. Fiscal tightening was significant in the United States, with a 4.6 percentage point decline in its cyclically adjusted primary balance in 2022 alone, reflecting the economic recovery from the pandemic. With rebounding private activity and households drawing on excess savings built up during the pandemic, overall demand weathered the withdrawal of governments’ support. The improvements in the cyclically adjusted primary balance in the euro area and the United Kingdom were smaller at 0.5 and 1.8 percentage point each, because further support measures were taken in response to a deterioration of the terms of trade stemming from Russia’s invasion of Ukraine. Japan announced a series of fiscal packages throughout the year, including measures to mitigate the deterioration in the cost of living. Other economies in Asia (Hong Kong SAR, Korea) also loosened their fiscal stances in 2022. The average debt-to-GDP ratio in advanced economies shed 10 percentage points between the end of 2020 and the end of 2022, thanks to favorable contributions from growth and inflation surprises. Nevertheless, the average current public-debt-to-GDP ratio of about 113 percent of GDP stands above its prepandemic levels. Over the medium term, fiscal tightening is projected to moderate or abate among advanced economies as a group. Under current projections for higher interest payments and lackluster growth, public debt would rise to about 118 percent of GDP over the medium term. Countries facing mounting pressures to engage in age-related spending (Japan), those contemplating further increases in public wages and other social spending (United Kingdom), and those expanding tax incentives, grants, and other fiscal measures to promote a transition to clean energy (United States) have steeper upward trajectories.

The chair of the Federal Reserve, Jerome H. Powell, has repeatedly undercut a central claim Republicans make as they seek sharp cuts in federal spending: Government spending is driving the nation’s still-hot inflation rate. Republican lawmakers say spending programs signed into law by President Biden are pumping too much money into the economy and fueling an annual inflation rate that was 6 percent in February — a decline from last year’s highs, but still well above historical norms. Mr. Powell disputed those claims in congressional testimony earlier this month and in a news conference on Wednesday, after the Fed announced it would once again raise interest rates in an effort to bring inflation back toward normal levels. Asked whether federal tax and spending policies were contributing to price growth, Mr. Powell pointed to a decline in federal spending from the height of the Covid-19 pandemic. “You have to look at the fiscal impulse from spending,” Mr. Powell said on Wednesday, referring to a measure of how much tax and spending policies are adding or subtracting to economic growth. “Fiscal impulse is actually not what’s driving inflation right now. It was at the beginning perhaps, but that’s not the story right now.” Instead, Mr. Powell — along with Mr. Biden and his advisers — says rapid price growth is primarily being driven by factors like snarled supply chains, an oil shock following Russia’s invasion of Ukraine and a shift among American consumers from spending money on services like travel and dining out to goods like furniture. Mr. Powell has also said the low unemployment rate was playing a role: “Some part of the high inflation that we’re experiencing is very likely related to an extremely tight labor market,” he told a House committee earlier this month. But the Fed chair’s position has not swayed congressional Republicans, who continue to press Mr. Biden to accept sharp spending reductions in exchange for raising the legal limit on how much the federal government can borrow. “Over the last two years, this administration’s reckless spending and failed economic policies have resulted in continued record inflation, soaring interest rates and an economy in a recessionary tailspin,” Representative Jodey C. Arrington, Republican of Texas and the chairman of the Budget Committee, said at a hearing on Thursday. Republicans have attacked Mr. Biden over inflation since he took office. They denounced the $1.9 trillion economic aid package he signed into law early in 2021 and warned it would stoke damaging inflation. Mr. Biden’s advisers largely dismissed those warnings. So did Mr. Powell and Fed officials, who were holding interest rates near zero and taking other steps at the time to stoke a faster recovery from the pandemic recession. Economists generally agree that those stimulus efforts — carried out by the Fed, by Mr. Biden and in trillions of dollars of pandemic spending signed by Mr. Trump in 2020 — helped push the inflation rate to its highest level in 40 years last year. But researchers disagree on how large that effect was, and over how to divide the blame between federal government stimulus and Fed stimulus. One recent model, from researchers at the Federal Reserve Bank of New York, the University of Maryland and Harvard University, estimates that about a third of the inflation from December 2019 through June 2022 was caused by fiscal stimulus measures. Much of that stimulus has already made its way through the economy. Spending on pandemic aid to people, businesses and state and local governments fell sharply over the last year, as emergency programs signed into law by Mr. Biden and former President Donald J. Trump expired. The federal budget deficit fell to about $1.4 trillion in the 2022 fiscal year from about $2.8 trillion in 2021. The Hutchins Center at the Brookings Institution in Washington estimates that in the first quarter of 2021, when Mr. Biden’s economic aid bill delivered direct payments, enhanced unemployment checks and other benefits to millions of Americans, government fiscal policy added 8 percentage points to economic growth. At the end of last year, the center estimates, declining government spending was actually reducing economic growth by 1 percentage point. Still, even Biden administration officials say some effects of Mr. Biden’s — and Mr. Trump’s — stimulus bills could still be contributing to higher prices. That’s because Americans did not immediately spend all the money they got from the government in 2020 and 2021. They saved some of it, and now, some consumers are drawing on those savings to buy things. Increased consumer spending from savings could be pushing the cost of goods and services higher, White House economists conceded this week in their annual “Economic Report of the President,” which includes summaries of the past year’s developments in the economy. “If the drawdown of excess savings, together with current income, boosted aggregate demand, it could have contributed to high inflation in 2021 and 2022,” the report says.