Weekend Musings Triggered by Observing That Noah Smith Is Working Hard to Make John Cochrane Appear Less Clueless About the World than He Is...
Noah Smith writes:
Noahpinion: Inflation predictions are hard, especially about inflation: John Cochrane responds here to a Brad DeLong jibe about inflation predictions. To make a long story short, back in 2009 Cochrane predicted inflation, it hasn't happened yet, and DeLong made fun of Cochrane for that fact. Cochrane essentially… [says:] The inflation prediction was (and is) a statement about risks, not a time-specific forecast….
Regarding Point 1, this is a very fair retort. Predictions are not necessarily forecasts. Saying "we are probably in a bubble that will burst sooner or later" is a different thing from saying "the bubble will burst at 10:36 A.M. next Thursday". I think people instinctively demand too many forecasts and not enough other kinds of predictions from macroeconomic models…
I disagree. I do not think that is a fair retort.
First, and less important, a reader of Cochrane (and Smith) would believe that I had said something like "Cochrane confidently predicted in March 2009 that an explosion of inflation was imminent". I don't think I did. What I said was:
Back in the spring of 2009… Sebastian Mallaby['s]… idea of the kind of people whom he really needed to push up onto the stage were people like… John Cochrane, claiming that the "danger is not 1932; the danger is Argentina, a massive run from Treasury debt" and "this insane idea of fiscal stimulus".:
John Cochrane, March 30, 2009: The New Financial Deal: What Do the 1930s Teach About Reforming Today's Financial Markets?: [T]he danger now is inflation. And I would say it's a greater danger than most of the other people [who have mentioned it] have said. Our danger now is a run on Treasury debt. It's not just can the Fed soak this stuff back up again, but can it soak this enormous amount of debt back up again when people don't want either money or Treasury bills or anything labeled "U.S. Government." The danger is not 1932; the danger is Argentina, a massive run from Treasury debt. And then monetary policy will not be able to do anything. You can fool around with interest rates all you want. When people don't want Treasury bills or money you're stuck…
If someone says "you were wrong to fear risk X" it is not a retort to say "I never said X would happen, I only said it was a risk!" In general, I think, you do get further when you engage what your critics say rather than what they did not say…
Second, and more important, any economist's claim "I did not say it would happen, I only said that it was a substantial risk that might happen" does not thereby create an Invincible Fortress of Rightness from within which the economist can laugh all critics to scorn.
If you say that something is a substantial risk and it does not come to pass, then--if you are an economist--you are committed to either (a) pointing at elements in the configuration of asset (and other) prices that demonstrated that people besides you thought it was a substantial risk at the time and took significant steps to insure themselves against it, or (b) explaining what was the market failure that kept people from hedging against the risk in such a way that we can see their hedges in market prices.
The inflation that Cochrane feared would follow the Federal Reserve's expansion of the high-powered money stock from $800B in 2008 to $1.7T in early 2009 has not come to pass. It has not come to pass even though the Federal Reserve has since not returned the high-powered money stock to normal but instead boosted it further to $2.7T and current market expectations are that it is more likely than not to be $3.3T by the end of the year. Yet there is no sign at all that anybody trading in asset markets is fearful enough of future inflation to price any probability of an acceleration of inflation into asset values.
That is what the 10-year and 30-year break-even inflation rates from the Treasury nominal-TIPS spread tell us. If there is anybody ought there who believes in the risk of future inflation and is willing to put their money on it, the break-even inflation spread should be high. It isn't. It wasn't.
And the explanation of what the market failure here is, of why we should not take what asset prices are telling us seriously--why there were (and are) big risks of inflation even though market prices say there are not? Missing. Completely missing.
If you are an economist, you are supposed to put forward a coherent argument--expectations, risks, prices and quantities, market failures--that adds up to a consistent whole. If you are an economist, you are supposed to follow the rules--and there are rules, aren't there?
Thus, Noah, I really do not think it is "a fair retort" to say:
- Risks of high inflation in 2009 were really really big!
- TIPS in 2009 were really really undervalued!
- Investors who were then holding TIPS had huge expected excess returns--and a return distribution with a large negative beta!
- No, I have no explanation for why asset market prices then did not match fundamentals.
Of course, if you are not an economist but an ideologue, or are simply playing for a Team Republican which wants to pressure the Fed to keep nominal demand growth depressed, then the rules are different. Then you can simply blather in an evidence-free fashion without restraint, and nobody can complain…