Russ Roberts suggested that I link to the paper that I mentioned in my talk. If you read it you will notice that it isn’t the sort of thing that gets published in academic journals. Looking back on it after 2 years, I now realize that I was already becoming a blogger 3 months before I had given any thought to becoming a blogger. Here is the link.
Archive for June 2010
(Sorry, you’ll need to open a few links to make sense of this post.)
Chongqing, which is the biggest city in western China, is very hilly. Thus 30,000 “stick men” make a living there carrying goods on the end of long poles:
Like most rural workers in big cities, Gui Laiyun sleeps in a basic 80-square-meter apartment, which he shares with about 50 other men. The beds here are made from wooden boards and rusty scaffolding. Rent is just 1.5 yuan a day.
For you Americans, that’s 22 cents a day for 1.6 square meters, or 17 square feet, of living space. That means about 6 men in a 10 by 10 foot room, as you can see from the picture in this link.
There are more Chinese people living in tiny places then there are people in America. It’s a good example of what Franklin Roosevelt referred to as “one third of a nation ill-housed,” although of course it is more than 1/3rd.
We normally think of the urban Chinese as the more affluent and the rural Chinese as being relatively poor. That’s true on average, but there are far more exceptions than you’d think. I suppose nobody’s surprised to see examples of poor migrant workers in the cities, but consider this example:
these are farmers houses that stretch for about 100 miles between Hangzhou and Shanghai. If youve seen
them in person the sheer scale of the devlopment is amazing, it basically looks like one vast urban suburb rather than
countryside. It took me over 2 hrs to get through it by train.
All the houses have steep roofs, turrets, towers and even onion domes, by the thousand. Its one of the most amazing ‘urban’
things Ive seen – seriously if anyones in Shanghai, take the train to Hangzhou and look out of your right window…
Theyre all built for free by the progressive local councils:
To see what he is talking about you need to open this link and scroll down to post#49. Then look at the pictures. One of them nearly blew me away. BTW, I have doubts about the accuracy of the statement that all those houses are “built for free.” I don’t even know what that means. But I did the Shanghai to Hangzhou drive in 2001, and I could see the beginnings of this amazing (appalling?) landscape beginning to take shape. As you look at the pictures toward the bottom of post #49, keep in mind you are looking at rural China.
But it gets even weirder. If you scroll down to post #55 of the same link you will see a Jetson-style rendering of a proposed “farmers apartment” building that is nearly the size of the Empire State building—proposed for a site in rural China. You’re probably thinking “Sure, the Chinese love those gee-wiz drawings, but how many actually get built? If you open up this link (post #255), you’ll see that the project is already mostly built. Question: Is there anywhere else in the world where a 1076-foot skyscraper would be built for “farmers” and located not in a city, but in the “countryside?”
Yes, I understand that Huaxi is the richest village in China, and is hardly typical. But I also think that there is far more wealth being accumulated in the rural parts of eastern China than many people realize.
When I used to hear about 800 million “rural Chinese” I pictured dusty little villages in western China. I may need to re-adjust my mental images.
What does this all mean? I have no idea. I’m sure you guys will inform me in the comment section. The only thing I am willing to predict is that if Tyler Cowen ever does a post on this, the term ‘Austrian’ will appear at least once.
Question for China experts: Do most Chinese still have to put 30% down on mortgages? If so, they just might avoid the worst of our sub-prime madness. If not . . . well I’d rather not think about that possibility.
PS. Interested readers can scroll up from post #255 to #244, which has a plausible sounding explanation of what is going on there.
Earlier I argued that the entire world economy hit a wall around 1975. Between 1950 and 1975 even dysfunctional models saw rapid growth. Even statist and autarchic models (The Soviet Union, Brazil, Mexico, etc) could round up peasants and put them into factories making steel and washing machines. But then the model ran out of gas when more sophisticated products and services were needed.
This Dani Rodrik post shows that Latin America grew fast from 1950 to 1975, and then hit a wall. Growth slowed sharply, as it did in most other places as well. Latin America did very poorly from 1975-90. After 1990 it has done somewhat better as a result of modest neoliberal reforms. The exception is Chile, which did a lot of neoliberal reforms, and has done a lot better than the rest of Latin America.
The same happened everywhere. The more neoliberal economies did better after 1975 than the more statist or autarchic economies; Thailand vs. Burma, UK vs. Italy, Sweden after 1994, vs Sweden before 1994, etc, etc.
Interesting, Rodrik reaches almost exactly the opposite conclusion.
Tyler Cowen has a series of increasingly persuasive posts criticizing the view that fiscal stimulus is the answer to our problems:
It is incorrect to argue that: “their high-savings export-oriented economy only works if someone else runs a high-debt economy and buys their stuff.” The Germans do just fine when they trade with current account surplus countries. If Portugal and Greece were more like Norway or the Netherlands, the German trade surplus might well go down, but the total value of German exports likely would go up (Germany exports mainly “normal goods”) and the German economy would do just fine.
The Germans are well aware that most of their neighbors have not managed their finances nearly as well as they have. How should we expect them to respond, if we, and others, now tell them that, after all their careful management, it is now time to run up debt to spend more money in their neighbors’ shops? (And that is in addition to significant ongoing EU transfers from Germany to poorer countries.) How would we respond to such a request?
. . .
How do we speak to the much poorer Chinese? Do we offer them aid or do we make demands on them? In this matter, the Germans to me seem more reasonable than the United States.
Some supporters of Keynesian theory act as if it is a well-established theory, as if skeptics are akin to global warming deniers. Count me as someone who believes in global warming, but has serious doubts about fiscal stimulus.
The first question is which Keynesian model? Keynes believed that fiscal stimulus almost always had a stimulative effect, because the economy was almost never at full employment. When I was in school we were taught that it was stimulative in a recession. By the 1990s the standard new Keynesian view was that fiscal policy had no effect if the central bank was doing its job, i.e. was targeting the expected inflation rate. Because fiscal stimulus works by boosting AD, and because higher AD boosts inflation expectations, any attempt to use fiscal stimulus will be thwarted by central banks that increasing focused on inflation targeting. Indeed even a flexible inflation target that also incorporated output would be enough to completely neutralize fiscal stimulus. The old Keynesians crawled into their caves, and monetary policy became the all-important stabilization tool. The General Theory had become the special theory–only applicable to cases where for some reason monetary stimulus was not an option.
Then something strange happened. Japan stumbled into a “liquidity trap” (or more specifically a condition of mild deflation and near-zero short term rates.) Interest rate-oriented monetary rules no longer worked in Japan, and the best and the brightest set out to fix the problem. Paul Krugman noticed that the Japanese were also running big fiscal deficits, and decided that fiscal stimulus might not be the solution:
But anyway, as a practical concern the main point about fiscal policy in Japan is that it is clearly nearing its limits. Over the course of the past 7 years Japan has experienced a secular trend toward ever-growing fiscal deficits; yet this has not been enough to close the savings-investment gap. One need not claim that fiscal policy is completely ineffective: as Adam Posen has emphasized, fiscal expansion has pushed up Japanese growth when tried. But how much fiscal expansion can the government afford? Between 1991 and 1996 Japan’s consolidated budget went from a surplus of 2.9 percent of GDP to a deficit of 4.3 percent, yet the economy was marked by growing excess capacity. When the Hashimoto government, alarmed by the long-run fiscal position, tried to narrow the deficit in 1997 the result was a recession; now fiscal stimulus is being tried once again. But projections already suggest that Japan may be heading for some awesome deficits – say 10 percent of GDP next fiscal year – with no end to the need for fiscal stimulus in sight. Given that Japan is already in far worse fiscal shape than, say, Brazil on every index I can think of – not just current deficit, but debt to GDP ratio and hidden liabilities arising from an aging population, the need for bank and corporate bailouts, etc., one has to wonder where the fiscal-expansion strategy is leading.
Good question! Instead the best option was for the Bank of Japan to stimulate the economy. Krugman said they must “promise to be irresponsible,” i.e. set a higher inflation target.
Then Mr. Bush came along, and Bush derangement syndrome set in among the left. He was viewed as such a singularly clueless and incompetent President that they assumed anything he supported must be bad. Bush supported big government, but more importantly he said he opposed big government. So if Bush said big government was bad, it must be good. So the old Keynesians started creeping out of their caves, and advancing their fiscal stimulus ideas. (Ironically, Bush himself was one of those old Keynesians, at least in regard to fiscal stimulus.)
The intellectual leaders of this movement tried to create a more respectable model to dress up their big government policy views. The far-fetched idea of an “expectations trap” was developed; the idea that markets would understand that central bankers were too conservative to implement higher inflation targets during deflation. It was never explained how fiscal stimulus would work in that case. If central banks are really that afraid of inflation, wouldn’t they also tighten up when fiscal stimulus threatened to boost aggregate demand? And indeed didn’t the Fed do exactly that in 1936-37 when they doubled reserve requirements in response to stronger aggregate demand supposedly coming from fiscal stimulus? And didn’t the BOJ tighten monetary policy three times in response to fears of inflation (not actual inflation!) during the past decade? So yes, conservative central banks may be a problem for monetary policy, but they are equally bad news for fiscal stimulus.
With pure theory not offering any answers here, we must turn to the empirical evidence. The opponents of fiscal stimulus dug up one case after another where fiscal stimulus didn’t seem to work, or where fiscal contraction was associated with strong growth. Each time the Keynesian said “that doesn’t count; they weren’t at the zero bound.” OK, so in the entire history if the world we basically have three cases to work with:
1. The US in the 1930s
2. Japan post-1994
3. The period since September 2008
The Great Depression lasted 12 years–so it can hardly be used to show that any policy (fiscal or monetary) is successful at ending recessions faster than they would end without stimulus. Some point to the effects of WWII. Yes, if you suddenly draft 13 million men into the military (the equivalent of 30 million today!) and give industry a blank check to produce as much military supplies as they can at profitable prices, you will get a big drop in unemployment. No one disputes that. Of course you will also get a drop in consumption, and isn’t the whole point of the multiplier to boost consumption and living standards?
What about the Japanese case? Japan ran large budget deficits, causing their national debt to balloon to over 100% of GDP. Even worse for the Keynesians, they did exactly the sort of deficit spending that is supposed to be the most potent, building infrastructure. And 16 years later, Japan is still in deflation. But of course that’s not how Keynesians see things. Today Krugman doesn’t emphasize how much they spent, how little they accomplished, and how big their debts have become, but exactly the opposite. They really never tried hard enough. Sure they paved over the once beautiful countryside with wasteful highway and bridge projects, but it wasn’t enough. If stimulus didn’t work, the answer seems no longer to be more money or more inflation, but rather more fiscal stimulus, more infrastructure, more concrete, still more concrete, and even more concrete.
And of course the same happened in America. After the $700 billion stimulus was passed unemployment rose by much more than was predicted to occur if no stimulus was enacted. The recovery was half as fast as the 1983-84 recovery, despite stimulus being twice as large (deficits of 6% of GDP then vs. 12% of GDP this time.) But again there were excuses—the economy had unexpectedly gotten much worse before the stimulus money was actually spent. OK, but I thought the new Keynesian models that all this is based on were predicated on the stimulative effect beginning when the policy was announced, not when the money was spent? Isn’t that the Woodford/Eggertsson approach; the model that the smarter new Keynesians now point too?
So we have a theory that shrinks to the point where it is only applicable in liquidity traps, and then disappears entirely if central banks use unconventional policy tools and/or try to subvert fiscal stimulus with monetary tightness. In other words, you must assume a bizarre reaction function from the central bank to even make it work in theory. Then you have little or no empirical evidence of fiscal stimulus actually working in even those rarefied zero rate bound environments. There may be some utopia where the General Theory is applicable; unfortunately we don’t seem to live there. (I presume everyone knows the literal meaning of utopia.) Ross Douthat has a similar take:
Technically, they could be right — but only in the same way that it’s possible that the Iraq War would have been a ringing success if only we’d invaded with a million extra soldiers. The theory is unfalsifiable because the policy course is imaginary. Maybe in some parallel universe there’s a Congress that would be willing to borrow and spend trillions in stimulus dollars, despite record deficits, if that’s what liberal economists said the situation required. But not in this one.
We don’t need more concrete, we need our central banks to commit to higher prices and NGDP.
John Cochrane has an interesting paper on the current economic crisis. I agree with some but not all of his analysis. Naturally I will focus on areas where I disagree. Here’s how he opens the paper:
I offer an interpretation of the macroeconomic events in the great recession of 2008-2009, and the subsequent outlook, focused on the fiscal stance of the U. S. government and its link to potential inflation. What happened? How did policies work? Are we headed for inflation or deflation? Will the Fed be able to follow an “exit strategy?” Will large government deficits lead to inflation? If so, what will that event look like?
I base the analysis on two equilibrium conditions, some form of which hold in almost every model of money and inflation: the valuation equation for nominal government debt and a money demand equation
We are both University of Chicago economists (although I suppose there is a slight difference between someone who teaches there and someone who merely took some classes.) So I am surprised that he would try to answer question like “are we headed for inflation” with a mathematical model. Why not just check out TIPS spreads? (Later he explains why, a point I’ll return to.)
Next Cochrane explains what he thinks caused the crisis:
Why did a financial crisis lead to such a big recession? We understand how a surge in money demand, if not accommodated by the Fed, can lead to a decline in output. I argue that we saw something similar — a “flight to quality,” a surge in the demand for all government debt and away from goods, services and private debt. In the fiscal context of (1), this event corresponds to a decrease in the discount rate for government debt.
Many of the Government’s policies can be understood as ways to accommodate this demand, which a conventional swap of money for government debt does not address. This story is in contrast to “lending channel” or “financial frictions” stories for the recession, essentially falls in aggregate supply.
As you know, I agree that this is mostly an AD problem, not a recession caused by financial system distress. I should add that as each day goes by the recession is less due to AD and more due to labor market rigidities. But AD is still a big factor. Were we differ is that he puts relatively more weight on fiscal policy:
Last, but perhaps most important: Will a fiscal inflation come with a boom or stagflation?
I argue that the fiscal valuation equation acts as the “anchor” for monetary policy, or the “expectation” that shifts the Phillips curve. A fiscal inflation is therefore likely to lead to the same stagflationary effects as any loss of “anchoring.”
Inflation can be explained from a fiscal perspective, but I see monetary policy as the dog and fiscal policy as the tail (except in places like Zimbabwe.) The Fed determines inflation and the fiscal authorities adjust their policies to accommodate the Fed’s preferred inflation path. Cochrane goes on to argue that future expected fiscal policy is the key:
Our most pressing question is, how might debt and deficits translate into inflation? Equation (3) gives an unusual answer and a warning: Expected futuredeficits St+j cause inflation today. Inflation need not wait for large deficits to materialize, for large debt to GDP ratios to occur, for monetization of debt or for explicit seigniorage. As soon as people figure out that there will be inflation in the future, they try to get rid of money and government debt now.
Yes, future expected inflation determines current inflation, a point I keep emphasizing here. But why the term ‘unusual answer?’ I thought this was now the standard (Woodfordian) view. Current inflation and AD are driven by future expected inflation and AD, and hence future expected fiscal and monetary policy. I suppose Cochrane is thinking of all those silly complaints that Obama wasn’t responsible for the economic deterioration in early 2009 because the stimulus money hadn’t been spent yet. Certainly the smarter sort of new Keynesians should have known better than to make that argument. (On the other hand some of the smarter Keynesians may occasionally let ideology cloud their judgment.)
Then Cochrane presents some evidence on the relationship between deficits and inflation:
One might well ask, “What surpluses?” as the U.S. has reported continual deficits for a long time. However, equation (3) refers to primary surpluses, i.e. net of interest expense. Figure 1 presents a simple estimate of the primary surplus, taken from the NIPA accounts, and expressed as a percentage of GDP. In fact, positive primary surpluses are not rare. From the end of the second world war until the early 1970s, the US typically ran primary surpluses, and paid off much of the WWII debt in that way. 1973 and especially 1975 were years of really bad primary deficits, on the tail of a downward trend, and suggestively coinciding with the outbreak of inflation. The “Reagan deficits” of the early 1980s don’t show up much, especially controlling for the natural business cycle correlation, because much of those deficits consisted of very high interest payments on a stock of outstanding debt. The return to surpluses in the late 80s and the strong surpluses of the 1990s are familiar, and suggestively correlated with the end of inflation. Our current situation resembles a cliff, motivating some of the concerns of this paper.
Regarding the last sentence; when the model says inflation and the markets say disinflation, a UC professor should go with the markets. In addition, I just don’t see the correlations he refers to (check graph on page 5.) The rate of inflation picked up in the 1960s, when we were still running primary surpluses. What caused that upsurge in inflation? I say monetary policy. And why did inflation slow sharply in the early 1980s? I don’t see his model giving any explanation. Maybe I missed something. I’m not saying there is no story you could tell. Maybe in 1982 people began anticipating the Clinton administration surpluses. But that doesn’t seem likely.
Then Cochrane applies his model to the current crisis:
The first issue is, why was there such a large fall in output? For once in macroeconomics we actually know exactly what the shock was — there was a “run” in the shadow banking system (See for example Gorton and Metrick, 2009b, or Duffie, 2010). But how did this shock propagate to such a large recession?
We have long understood that a sharp precautionary increase in money demand, if not met by money supply, would lead to a decline in aggregate demand. With price-stickiness or dispersed information, a decline in aggregate demand can express itself as a decline in real output rather than a decline in the price level. This is in essence Friedman and Schwartz’s explanation for the great depression. However, this story cannot credibly apply to the 2008-2009 recession. The Federal Reserve flooded the country with money (reserves). There is no evidence for a flight to money at the expense of government bonds.
Two p0ints. I agree that there was an increase in the demand for both money and T-bonds. But I disagree about the Fed flooding the economy with money (and later I’ll argue that Cochrane also disagrees with this assertion.) Interest bearing reserves are not “money,” at least not the non-interest-bearing asset that Friedman and Schwartz had in mind. Nevertheless, the non-interest-bearing base did rise by quite a bit in Japan–so I won’t belabor this point.
As the financial crisis took off in the third week of September 2008, the Federal reserve swiftly cut the Federal Funds target to a range between 0 and 25 bp, and signaled it would leave interest rates there for a long time (Figure 4). Inflation declined, never turned to deflation so real rates on these assets remained near zero.
Expected inflation did turn negative, and the real interest rate on 5 year TIPS rose from 0.5% to 4.25% between July and November 2008. But I agree that real rates don’t provide a reliable indicator, so let’s skip over this issue.
Excess reserves rose from $6b to $800b. While it’s hard to disprove anything in economics, it certainly seems an uphill battle to argue that the recession resulted from a failure by the Fed to accommodate shifts in money demand.
We will see about that.
The combination of near-zero government rates and reserves paying interest, means that the distinction between government bonds and money (reserves) was a third-order issue for financial institutions, especially compared to the very high interest rates, lack of collateralizability, and illiquidity of any instrument that carried a whiff of credit risk. If they wanted more of either, they wanted more of both.
. . .
The Fed has also started paying interest on reserves. Reserves that pay interest are government debt. By creating such reserves the Fed can rapidly expand the supply of shortterm, floating rate debt, without needing any cooperation from the Treasury or a rise in the Congressional debt limit. It also can execute massive open-market operations at the stroke of a pen. With a trillion dollars of excess reserves, changing the interest on reserves from 0 to the overnight rate is exactly the same thing as a trillion-dollar open-market operation.
. . .
The fact that reserves now pay interest dramatically changes our interpretation of the data. Reserves that pay market interest are debt, not money.
Exactly. These reserves are debt, not money. So in fact this case does not provide much evidence against the monetarist view. Cochrane continues:
This is not how the Fed thinks about its policy actions, at least as I interpret Fed statements. The first stage, trading private for government debt without increasing money, was, to the Fed, a way to support private credit markets without the inflationary effect that increasing M might have had. The Fed wanted to stimulate in a noninflationary way, an idea beyond my simple analysis.
Yes, how the Fed came to the conclusion that it was possible to boost AD without boosting inflation is also something far beyond my simple analysis. I am as puzzled as Cochrane.
Many critics objected that fiscal stimulus won’t stimulate in time, because the spending will come too late, after the recession is over. This reflects the standard analysis, enshrined in undergraduate textbooks since the 1970s, that fiscal policy, affects “demand” as it is spent. Equation (14) suggests the opposite conclusion. In order to get stimulus (inflation) now, future deficits (St+1 for large pi) are just as effective as current deficits, and possibly more so.
Again, this just floors me. Cochrane may be right, but I am stunned that the standard view of fiscal policy doesn’t take expectations into account. If there are any grad students out there, please ”say it ain’t so.”
But then Cochrane seems to assume modern monetarism is equally ignorant of expectations:
But in our framework, it’s hard to see how quantitative easing can have any effect. The Fed can increase reserves M and decrease B, but nobody cares if it does so. Agents are happy to trade perfect substitutes at will. Velocity V will simply absorbs any further changes. The argument must rest on the idea that V is fixed, but why should the relative demand for perfect substitutes be fixed? (With interest on reserves, the same logic applies even at nonzero interest rates, and one would expect the argument to hold as an approximation at small positive rates.)
Cochrane is comparing an outdated monetarist model where current monetary policy drives current and future AD, with a sophisticated fiscal model where current AD is driven by future expected deficits. But that’s not fair. We have known for a long time that it is future expected monetary policy that drives current AD. The fact that money and T-bills are now almost perfect substitutes does not in any way inhibit the Fed from targeting the price level (unless you assume that the liquidity trap will last forever.) Believe me, when T-bill rates get up to 2% or 3%, then non-interest-bearing reserves will not be considered perfect substitutes for T-bills, demand for excess reserves will fall almost to zero, and the Fed will have its usual ability to control the price level path that comes from its position of being the monopoly producer of the stuff we carry around in our wallets. I don’t plan on carrying T-bills to go shopping at Wal-Mart. The quickest way to get out of the liquidity trap is to target a much higher NGDP growth path than what is currently expected. That will dramatically lower the demand for base money. (And of course they can also pay negative interest on bank reserves.)
What about a “helicopter drop?” Wouldn’t this increase money M and inflate? A helicopter drop is at heart a fiscal operation. To implement a drop in the U. S., the Treasury would borrow money, issuing more debt. It would spend the money as a government transfer. Then the Federal Reserve would buy the debt, so that the money supply increased. A real drop of real cash from real helicopters would be recorded as a transfer payment, a fiscal operation. Conversely, even a helicopter drop would not be “stimulative” if everyone knew that the money would be soaked up the next day in higher taxes, or by the Fed, i.e. by future taxes.
Thus, Milton Friedman’s helicopters have nothing really to do with money. They are instead a brilliant device to dramatically communicate that this cash does not correspond to higher future fiscal surpluses; that this money will be left out in public hands as in a currency reform. To be effective, a monetary expansion at near zero rates must be accompanied by a non-Ricardian fiscal expansion as well. People must understand that the new debt or money does not just correspond to higher future surpluses.
I’m glad this came up, as I was about to do a post on the widely misunderstood “helicopter drop.” These money drops don’t do anything that an open market purchase can’t do, unless it changes fiscal policy expectations. An OMP at the zero bound will be highly inflationary if it is expected to be permanent, and not at all inflationary if it is expected to be temporary. And exactly the same is true of the helicopter drop. There is a strong effect if expected to be permanent, and almost no effect if expected to be temporary.
Cochrane does not explicitly forecast higher inflation. But his model suggests that it is likely to be a problem, as the graph on page 5 shows a fiscal situation that is far worse than what we saw in the 1970s. Here he first discusses three reasons why the Fed doesn’t fear inflation, and then hints that he sees worrisome signs of inflation:
The first asserts that “inflation expectations have been relatively stable” and points to a graph (figure 2) of actual inflation. The second (under “prices”) summarizes median survey data, excusing a jump in short-term expectations by energy prices and pointing to more stable long-term expectations. The third inferred expectations from Treasury vs. TIP yields, again arguing that “short-term” expectations might have risen but “long-term” expectations had not changed much. In evaluating the latter, we should remember that neither surveys nor long-term yields gave any warning of inflation in the 1970s nor disinflation in the 1980s. These are the only mention of expectations or documentation of the FOMC and Chairman’s assertions in the document. Occasionally, sophisticated Fed statements allude to the New-Keynesian idea that expectations are anchored by a belief that the Fed will respond quickly to inflation, though not why people should have such a belief. The volume of popular press coverage of deficits and inflation — clearly about expected future inflation — and even the ads for gold on cable TV suggest at least a more widespread concern about inflation than has been present for some time.
I think he is grasping for straws here. If you want a relatively direct take on inflation expectations you look at TIPS spreads and CPI futures markets. Real gold prices are distorted by massive Asian demand.
I share many of Cochrane’s criticisms of Keynesianism. I like his discussion of the need for a dynamic Laffer curve, and his contempt for “slack” models of inflation. And I agree that a lack of AD, not financial turmoil, explains the severe phase of the recession. But I disagree on a few key points:
1. Because money and T-securities are not close substitutes during normal times, the Fed can control the price level in the long run.
2. This means that open market purchases that are permanent do affect the price level. They affect future expected prices and hence current prices.
3. The Fed can create expectations that open market purchases are permanent if it sets an explicit target for the price level or NGDP.
4. Monetary policy is the dog in America, fiscal policy is the tail. This may reverse in the future, but . . .
5. Markets aren’t afraid of fiscal inflation. They saw what happened in Japan. TIPS markets are much better inflation indicators than gold prices.
BTW, this post was inspired by another post called “Is John Cochrane Sumnerian Now?“ I vaguely recall that he had a more finance-oriented view of the recession when we debated last year. But that is probably wishful thinking on my part. My memory may be faulty, and even if it isn’t I doubt I had any effect on his views.