Robert Hetzel and the risks of inflation

Here’s the abstract of Robert Hetzel’s new Mercatus paper, which discusses the Fed’s response to Covid-19:

The quantity theory, which posits a causal relationship between money and prices, is among the oldest theories in economics. Starting in March 2020 as the COVID-19 pandemic affected the United States, money surged at a historically rapid pace. Historical experience, most recently with the Great Inflation of the mid-1960s through the 1970s, suggests that an uncontrolled surge in inflation is coming. Other factors in the intellectual and political environment are also reminiscent of the Great Inflation. The Federal Reserve has reverted to its 1950s “cost and availability” view of monetary transmission. There also exists a widespread belief that inflation is a nonmonetary phenomenon. In Keynesian terms, because the Phillips curve, which relates inflation and unemployment, is presumed to be flat, the Fed can push the unemployment rate to historically low levels. Federal Open Market Committee (FOMC) chair Jerome Powell asserts that the course of the recovery will be dictated by the behavior of the virus. That makes sense in that the recession arose as a shock to potential output. Powell and the FOMC, however, treat the recession as if it originated in a large negative aggregate-demand shock requiring extremely stimulative monetary policy. The FOMC should follow a rule that ensures that the spring 2020 bulge in money dissipates.

The paper presents a monetarist critique of recent Fed policy.

I’m less worried about inflation, as you don’t see high inflation expectations in the TIPS markets. But Bob is right that the intellectual climate increasingly resembles the 1960s, when belief in a (flawed) Keynesian model led to some serious policy errors. So this is certainly something to keep an eye on.



15 Responses to “Robert Hetzel and the risks of inflation”

  1. Gravatar of marcus nunes marcus nunes
    13. October 2020 at 15:56

    It sure does remind of the 60s. A “time warp”
    Powell (2020)
    The recovery will be stronger and move faster if monetary policy and fiscal policy continue to work side by side.

    James Tobin (1962)
    The Council sought to liberate mon pol to focus it squarely on the same macroeconomic objectives that should guide fiscal policy.

  2. Gravatar of Benjamin Cole Benjamin Cole
    13. October 2020 at 16:37

    It is not just the Fed—central bankers globally, and nearly in unison, are calling for more fiscal stimulus. Sheesh, Stanley Fischer is calling for. Federal Reserve armed with a fiscal facility.

    Is this Keynesianism? Or a fear that too-easy money will lead to inflation, so let the fiscal side do the heavy lifting?

    If the globe ever exits the C19 miasma, and we still do not have inflation, then orthodox macroeconomics (which has been growing weaker and weaker in explanatory power) will probably have to undergo a reformation (as older economists die off).

    Some things to ponder: Capital markets are globalized, the economy is globalized, and money is a very, very fungible fungible commodity. But there are four or five major central banks in action, and some minor actors too. So the Fed buys Treasuries, and injects a couple trillion into globalized capital markets—capital markets at about $400 trillion in total size. So what?

    Should macroeconomists begin to think about central banks as a group, and not different central banks in isolation?

    Are money-financed fiscal programs monetary or fiscal policy?

    Is QE, in concert with fiscal deficits, really just a variation of money-financed fiscal programs? (Michael Woodford says so.)

    Are there elements of MMT that make sense if fiscal and monetary policy are married through QE? Or money-financed fiscal programs?

    If national debt can be monetized without inflationary result (see Bank of Japan, the Fed, the ECB)…then, what is debt? Monetizing debt is bad (bad!) in theory…but has been happening for decades.

    As the orthodox macroeconomist says, “What you are doing may work in reality, but more importantly, does it work in theory?”

    And, as my late great Uncle Jerry used to say, “If you are not confused, then maybe you don’t understand the facts.”

  3. Gravatar of Cody Boyer Cody Boyer
    13. October 2020 at 20:11

    If TIPS markets don’t expect high inflation, then as far as I can tell these are the only possibilities: Hetzel is just wrong about the amount of money that has been created, or markets don’t believe in the quantity theory of money (or maybe they think prices would rise if a sufficiently large amount of money is added, but they think prices are sticky enough that what has been added won’t have a big effect). Are there other possibilities? I trust markets more than anything/anybody else regarding inflation predictions, but why are the market’s inflation expectations low?

  4. Gravatar of rayward rayward
    14. October 2020 at 01:52

    The massive government spending and debt to fund it have little to do with Keynes and lots to do with a public health crisis. This isn’t about using government spending to spur economic growth, this is about supporting workers who can’t work and businesses that can’t engage in business because of the pandemic. On the other hand, the massive budget deficits ($1 trillion a year) adopted by the Republicans in 2017 was a perverted application of Keynes: government spending to spur economic growth at a time of economic expansion. It’s true that the amount of money in circulation spiked in March and has continued to grow since. Why? It isn’t to facilitate spending. Hoarding is more like it. Where is all that money? Under the mattress? The velocity of money must have crashed as the money in circulation spiked. As for the risk that government will use inflation to repay all that government debt, that’s another reason to adopt Sumner’s hobby horse: NGDP targeting.

  5. Gravatar of Benjamin Cole Benjamin Cole
    14. October 2020 at 02:44

    This is the Atlanta Fed Business Inflation Expectations report. About 1.6% for year ahead. Will be updated today.

    If “expectations matter” then here you go.

    Also, if Biden wins, perhaps business operators expect a weaker economy, would would also be deflationary. Biden promises big jump in corporate income taxes, and an “end to the era of shareholder capitalism.”

    Biden up by wide margins in the polls. I guess the public likes what it sees.

  6. Gravatar of Christian List Christian List
    14. October 2020 at 02:46


    I assume Scott keeps the criticism regarding Hetzel’s inflation forecast rather moderate because it’s a Mercatus colleague and because Scott is a polite person. You have to read between the lines. He cannot criticize Hetzel more strongly without being rude.

    Quite some libertarians seem to be predicting inflation for 20-30 years now, without it ever happening. So even if someday they are right once, they were still wrong all the other years.

  7. Gravatar of Julius Probst Julius Probst
    14. October 2020 at 03:24

    Hi Scott.
    Unrelated to this post, but I know that you mentioned Rognlie and housing a couple of times, maybe Econlog, so I will just leave this here:
    A short blog post in which I adjust the labor share for imputed rents and depreciation.
    Long story short, the net wage share does not seem to be declining, last graph in the post:

  8. Gravatar of Mark Mark
    14. October 2020 at 04:08

    Didn’t a lot of the money created just go into savings and investments, as the savings rate soared to an unprecedented level during the pandemic? If the spring 2020 money bulge mostly went into savings, then it seems that it did drive up prices substantially—just asset prices rather than consumer prices.

  9. Gravatar of Philo Philo
    14. October 2020 at 08:02

    “The Federal Reserve has reverted to its 1950s ‘cost and availability’ view of monetary transmission.” What view has it superseded? What is the right view of monetary transmission, and how important is it for the Fed to take the right view? In short, is the quoted sentence good news or bad news, and how good or bad is it?

  10. Gravatar of ssumner ssumner
    14. October 2020 at 08:11

    Rayward, You said:

    “This isn’t about using government spending to spur economic growth, this is about supporting workers who can’t work and businesses that can’t engage in business because of the pandemic.”

    Really? Giving $1200 to every single middle class American with a job is “supporting workers who can’t work”? Could have fooled me.

    Christian. You’ll never get it. I base my tone on whether the arguments are intelligent or unintelligent, not on whether I happen to agree with the conclusions.

    Mark, Yes, demand for money as saving has soared this year. Even cash. Indeed even coins!

  11. Gravatar of Lizard Man Lizard Man
    14. October 2020 at 11:06

    I guess the question is whether demand for money falls at some point in time? At the least that would be the crucial ingredient for inflation under a quantity theory of money. Yet it seems to me that the demand for money (or near substitutes) has been rising since at least the financial crisis, and I don’t see it falling in the future. I guess I just don’t see new consumer goods that are so awesome that people decide it is worth it to liquidate their savings to buy them, and relatedly, I don’t see a lot of great real world investment opportunities, even if the price of financial assets continues to grow strongly.

    Now might be a good time for governments to invest in things with high rates of social returns. Money spent on lead and other heavy metal abatement seems like a good place to start, and evidence seems to indicate that reducing air pollution has lots of benefits in increasing learning among children and increasing QALYs. The US sure could use a lot more police officers as well to deal with and prevent shootings and gun crime.

  12. Gravatar of D.O. D.O.
    14. October 2020 at 12:55

    My two cents is that markets believe in Fed being an inflation hawk and taking “whatever it takes” measures at the first sign of elevated inflation even if employment situation and RGDP are not in a good shape.

  13. Gravatar of ssumner ssumner
    14. October 2020 at 13:37

    Julius, Thanks. Very interest post.

  14. Gravatar of Thomas Hutcheson Thomas Hutcheson
    16. October 2020 at 05:19

    “Powell and the FOMC, however, treat the recession as if it originated in a large negative aggregate-demand shock requiring extremely stimulative monetary policy.’

    This is doubly puzzling.

    First, “extremely stimulative monetary policy” [action] is exactly what IS needed to keep NGDP on a 4-5% growth track whether the shock is demand or supply. [The difference in outcome is how the 4-5% is distributed between inflation and real growth]

    Second, the Fed has NOT responded with “extremely stimulative monetary policy.” Rather it has allowed inflation to DECLINE which is bad enough in a demand shock but worse in a supply shock, which the pandemic must be at least to some degree.

    “Federal Open Market Committee (FOMC) chair Jerome Powell asserts that the course of the recovery will be dictated by the behavior of the virus.”

    This is exactly right. Even if the Fed kept NGDP growing at 4-5%, (which it apparently has no intention of doing) the recovery in real income will depend on the health and supply disruption effect of the virus.

  15. Gravatar of Spencer B Hall Spencer B Hall
    16. October 2020 at 09:27

    re: “Historical experience, most recently with the Great Inflation of the mid-1960s through the 1970s, suggests that an uncontrolled surge in inflation is coming.”

    Tripe. The period from 1961 to 1981 was influenced by the “monetization of time deposits”, the end of gated bank deposits. This vastly accelerated the transactions’ velocity of money, i.e., bank debits.

    Increased use of, and faster air traffic, speeded up the time for checks and clearing balances to be credited to the receiving banks, and the Fed further abetted the process by reducing “float” time to a maximum of two days (similar to the productivity enhancements from “Check 21” services on October 28, 2004).

    The culmination of this speeding up process came with the introduction of electronic clearing (the epochal supplanting of clerical hand-held processing, e.g., lockbox processing, the closest collection and remittance processing of account receivables, viz., the robotized on-line, real-time, immediate streaming of economic activity, e.g., new technology utilizing OCR and data validation.

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