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Fiscal Inflation Is Simple With This One Weird Trick

03 Thursday Feb 2022

Posted by in Fiscal policy, Inflation

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I’ll get to the weird trick right off the bat. Then you can read on if you want. The trick really is perverse if you believe in principles of sound credit and financial stability. To levy a fiscal inflation tax, all the government need do is spend like a drunken sailor and undermine its own credibility as a trustworthy borrower. One way to do that: adopt the policy prescriptions of Modern Monetary Theory (MMT).

A Theory of Deadbeat Government

That’s right! Run budget deficits and convince investors the debt you float will never be repaid with future real surpluses. That doesn’t mean the government would literally default (though that is never outside the realm of possibility). However, given such a loss of faith, something else must give, because the real value government debt outstanding will exceed the real value of expected future surpluses from which to pay that debt. The debt might be in the form of interest-bearing government bonds or printed money: it’s all government debt. Ultimately, under these circumstances, there will be a revised expectation that the value of that debt (bonds and dollars) will be eroded by an inflation tax.

This is a sketch of “The Fiscal Theory of the Price Level” (FTPL). The link goes to a draft of a paper by John Cochrane, which he intends as an introduction and summary of the theory. He has been discussing and refining this theory for many years. In fairness to him, it’s a draft. There are a few passages that could be written more clearly, but on the whole, FTPL is a useful way of thinking about fiscal issues that may give rise to inflation.

Fiscal Helicopters

Cochrane discusses the old allegory about how an economy responds to dollar bills dropped from a helicopter — free money floating into everyone’s yard! The result is the classic “too much money chasing too few goods” problem, so dollar prices of goods must rise. We tend to think of the helicopter drop as a monetary policy experiment, but as Cochrane asserts, it is fiscal policy.

We have experienced something very much like the classic helicopter drop in the past two years. The federal government has effectively given money away in a variety of pandemic relief efforts. Our central bank, the Federal Reserve, has monetized much of the debt the Treasury issued as it “loaded the helicopter”.

In effect, this wasn’t an act of monetary policy at all, because the Fed does not have the authority to simply issue new government debt. The Fed can buy other assets (like government bonds) by issuing dollars (as bank reserves). That’s how it engineers increases in the money supply. It can also “lend” to the U.S. Treasury, crediting the Treasury’s checking account. Presto! Stimulus payments are in the mail!

This is classic monetary seigniorage, or in more familiar language, an inflation tax. Here is Cochrane description of the recent helicopter drop:

“The Fed and Treasury together sent people about $6 trillion, financed by new Treasury debt and new reserves. This cumulative expansion was about 30% of GDP ($21,481) or 38% of outstanding debt ($16,924). If people do not expect that any of that new debt will be repaid, it suggests a 38% price-level rise. If people expect Treasury debt to be repaid by surpluses but not reserves, then we still expect $2,506 / $16,924 = 15% cumulative inflation.”

FTPL, May I Introduce You To MMT

Another trend in thought seems to have dovetailed with the helicopter drop , and it may have influenced investor sentiment regarding the government’s ever-weakening commitment to future surpluses: that would be the growing interest in MMT. This “theory” says, sure, go ahead! Print the money government “must” spend. The state simply fesses-up, right off the bat, that it has no intention of running future surpluses.

To be clear, and perhaps more fair, economists who subscribe to MMT believe that deficits financed with money printing are acceptable when inflation and interest rates are very low. However, expecting stability under those circumstances requires a certain level of investor confidence in the government fisc. Read this for Cochrane’s view of MMT.

Statists like Bernie Sanders, Alexandria Ocasio-Cortez, and seemingly Joe Biden are delighted to adopt a more general application of MMT as intellectual cover for their grandiose plans to remake the economy, fix the climate, and expand the welfare state. But generalizing MMT is a dangerous flirtation with inflation denialism and invites economic disaster.

If This Goes On…

Amid this lunacy we have Joe Biden and his party hoping to find avenues for “Build Back Better”. Fortunately, it’s looking dead at this point. The bill considered in the fall would have amounted to an additional $2 trillion of “infrastructure” spending, mostly not for physical infrastructure. Moreover, according to the Congressional Budget Office, that bill’s cost would have far exceeded $2 trillion by the time all was said and done. There are ongoing hopes for separate passage of free community college, an extended child tax credit for all families, a higher cap for state and local income tax deductions, and a host of other social and climate initiatives. The latter, relegated to a separate bill, is said to carry a price tag of over $550 billion. In addition, the Left would still love to see complete forgiveness of all student debt and institute some form of universal basic income. Hey, just print the money, right? Warm up the chopper! But rest easy, cause all this appears less likely by the day.

Are there possible non-inflationary outcomes from ongoing helicopter drops that are contingent on behavior? What if people save the fresh cash because it’s viewed as a one-time windfall (i.e., not a permanent increase in income)? If you sit on such a windfall it will erode as prices rise, and the change in expectations about government finance won’t be too comforting on that score.

There are many aspects of FTPL worth pondering, such as whether bond investors would be very troubled by yawning deficits with MMT noisemakers in Congress IF the Fed refused to go along with it. That is, no money printing or debt monetization. The burgeoning supply of debt would weigh heavily on the market, forcing rates up. Government keeps spending and interest costs balloon. It is here where Cochrane and critics of FTPL have a sharp disagreement. Does this engender inflation in the absence of debt monetization? Cochrane says yes if investors have faith in the unfaithfulness of fiscal policymakers. Excessive debt is then every bit as inflationary as printing money.

Real Shocks and FTPL

It’s natural to think supply disruptions are primarily responsible for the recent acceleration of inflation, rather than the helicopter drop. There’s no question about those price pressures in certain markets, much of it inflected by wayward policymakers, and some of those markets involve key inputs like energy and labor. Even the median component of the CPI has escalated sharply, though it has lagged broader measures a bit.

Broad price pressures cannot be sustained indefinitely without accommodating changes in the supply of money, which is the so-called “numeraire” in which all goods are priced. What does this have to do with FTPL or the government’s long-term budget constraint? The helicopter drop certainly led to additional money growth and spending, but again, FTPL would say that inflation follows from the expectation that government will not produce future surpluses needed for long-term budget balance. The creation of either new money or government debt, loaded the chopper as it were, is sufficient to accommodate broad price pressures over some duration.

Conclusion

Whether or not FTPL is a fully accurate description of fiscal and monetary phenomena, few would argue that a truly deadbeat government is a prescription for hyperinflation. That’s an extreme, but the motivation for FTPL is the potential abandonment of good and honest governing principles. Pledging an inflation tax is not exactly what anyone means by the full faith and credit of the U.S. government.

Poverty Maintenance Is Not A Win

01 Wednesday Apr 2015

Posted by in Poverty, Uncategorized

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obama-new-normal

Merely keeping a patient alive is inferior to curing the disease. Likewise, merely allowing the impoverished to live under tolerable conditions is inferior to eliminating the underlying causes of poverty. Evidence for the former is used by Harvard Professor Christopher Jencks to proclaim the war on poverty a success. That is the upshot of his recent article in The New York Review of Books. But does the maintenance of a permanent dependent class constitute success? I believe that our goals should be loftier, and President Johnson’s original goals for the War on Poverty went much farther than Jencks suggests.

Ostensibly a review of other work by Martha Bailey and Sheldon Danziger, Professor Jencks devotes most of his essay to arguing that the official poverty rate published by the Census Bureau is distorted, and that a “corrected” measure has declined since the “war” was initiated by Johnson in the 1960s. The official rate has fluctuated in a range of 11-15% since the mid-1960s. Jencks corrects the 2013 rate of 14.5% for 1) the value of non-cash benefits received by certain program recipients (-3%); 2) the omission of refundable tax credits from the official incomes of employed individuals below the poverty line (-3%); and 3) a change in the price index used to adjust the official poverty thresholds over time to one that does not overstate changes in the cost of living (-3.7%). These three adjustments would reduce the poverty rate in 2013 to just 4.8%.

Taken at face value, that reduction is impressive, but the third adjustment is not directly attributable to antipoverty programs. It could also be due to economic growth or other factors. Jencks notes the following:

“Both liberals and conservatives tend to resist the idea that poverty has fallen dramatically since 1964, although for different reasons. Conservatives’ resistance is easy to understand. They have argued since the 1960s that the federal government’s antipoverty programs were ineffective, counterproductive, or both. 

Liberals hear the claim that poverty has fallen quite differently, although they do not like it any better than conservatives do. Anyone, liberal or conservative, who wants the government to solve a problem soon discovers that it is easier to rally support for such an agenda by saying that the problem in question is getting worse than by saying that although the problem is diminishing, more still needs to be done.”

For my own part, I believe that many antipoverty programs succeed only as palliatives. They have not succeeded in breaking the cycle of poverty and dependence on the state. In other words, successful programs must foster self-sufficiency, which is a superior goal from a humanitarian and a Libertarian perspective. Jencks plans a follow-up on the “successes and failures specific anti-poverty programs”, but merely paying alms to the poor establishes a very low threshold for success.

In fairness to Jencks, anti-poverty programs serve a large number of individuals who are incapable of providing for themselves for a variety of reasons such as age, physical and mental disabilities. While it is beyond the scope of this post, some argue that private charities are more effective at providing for these individuals as well as the able poor. A greater role for charity could even be facilitated via public funding, but in any case, a larger role for private charity should always be on the menu of policy options.

A basic failing of many welfare programs is an incentive problem: able recipients perceive a penalty for work effort (additional hours or even kinds of employment) if rising earned income is associated with reduction or elimination of program benefits. This means that participants face a very high effective marginal tax rate on earned income.

This article from The CATO Institute contains a good overview of the federal welfare system, which consists of 126 separate programs. The article contains somewhat more detailed on the largest anti-poverty programs, such as Refundable Tax Credits (the Earned Income Tax Credit (EITC), and Child Tax Credit (CTC)), Supplemental Security Income (SSI – for aged, blind and disabled), SNAP (food stamps), housing subsidies, child nutrition (WIC), Temporary Assistance For Needy Families (TANF) and unemployment insurance. Social Security is also included since it pays benefits to many low income seniors.

The CATO analysis shows that by one measure, refundable tax credits are by far the most cost efficient at lifting people out of poverty at a point in time, at least among the large programs, followed by SSI and using subsidies. In-kind programs such as SNAP and WIC tend to be less targeted and less effective by this measure. There is fairly widespread agreement that the tax credits have better incentives for work effort, but there are still high marginal tax rates in the phase-out range, a marriage penalty, and the credits are paid only once a year as tax refunds. Some contend that the phase-out of the EITC discourages labor supply even more than the credit increases labor supply at lower incomes. Still others believe that adding certain work requirements would make the EITC a more effective measure:

“The [EITC] clearly does reduce poverty, but it raises work levels far less than some of the statistical studies of the past decade claim, and it appears to do so by encouraging working people to keep working, rather than driving the non-working poor toward jobs. If we wish the credit to promote work as well as raise incomes, we … must add other suasions to promote and enforce work, such as those found in the more successful work-incentive experiments…. These include mandating participation in work programs and setting some threshold of working hours that claimants have to achieve to get benefits.”

The incentive effects of other programs are more negative than the tax credits. This paper found that the food stamp program reduces employment and hours worked. The TANF program, which was the successor to Aid To Families With Dependent Children (AFDC), also exposes recipients to high marginal tax rates. While CATO has been criticized for analyzing the combined impact on marginal tax rates of up to eight different programs, there is little question that the incentive problem is compounded for participants in multiple programs.

There are many different approaches that can be explored for eliminating poverty, supporting those who can’t work and ending dependency for those who can. Certainly, the work incentives of existing anti-poverty programs can be improved in a number of ways. More inventive approaches can be tested at the state level. However, programs such as guaranteed incomes should be eschewed, as they tend to aggravate the incentive problem and encourage dependency.

There are many other approaches to attacking poverty and its causes that do not strictly qualify as “welfare reform.” These include measures that would improve education and employment prospects, including apprenticeship and other training programs. School choice is a fundamental reform with enormous potential to improve the quality of education among poor children. Transitioning to market-based health care reform, including competition among health insurers, would reduce medical costs across the board. Eliminating costly regulation of business can encourage economic growth, which is basic to lifting the incomes of the working poor. Minimum wage legislation should be avoided as it simply eliminates opportunities for the least productive members of society and it is not well-targeted at the poor. Tax reform that encourages saving and investment, including corporate tax reform, will increase the economy’s long-term growth potential, as would a general reduction in the size of the public sector. An end to wasteful subsidies to “privileged” industries can minimize malinvestment and release resources to uses that pass a true market test, leading to a more general prosperity.