John Cochrane: "What Chicago Does 'Know' Is Scholarship… We Take a Little Time to Research What People Actually Have to Say Before Calling Them… Less than 'Half-Intelligent' [like] DeLong [Does]…"
Reading Paul Krugman calls to mind that I never reacted to John Cochrane's July 2012 failure to mark his beliefs to market and, instead, doubling down on his claim that the biggest risk the U.S. economy faces is that of becoming "Argentina" "quickly".
I must say that if I had been opining stridently about issues of public policy without doing my homework five years ago, and if between then and now events had developed in directions strongly contrary to my expectations, I would not double down on what I had thought then--I would rather try hard to do my homework and to mark my beliefs to market.
And if I were going to criticize people for not citing my work, I would not claim that a sentence they wrote which comes immediately after a four-paragraph quote from me as an example, and I would have read their explanation of why they think expansionary fiscal policy right now does not raise the risks of "fiscal dominance" rather than remain in ignorance of it.
But to each his own.
The Grumpy Economist: Krugman, Delong and Inflation: Yes, I've been worried for some time that our current debt could lead to inflation. And yes, that inflation has so far not happened…. Well, they made fun of Friedman when he said in 1968 that inflation was coming. They made fun of Greenspan when he said in 1996 that stocks seemed awfully high, and stocks went up for a few more years.
I gotta interrupt: Friedman in the late 1960s was right. He--correctly--saw inflation rising because he had theory and evidence on supply and demand in the labor market. But Greenspan in 1996 was wrong: since late 1996 the S&P 500 has produced a real return of 5.6%/year.
Does Cochrane know this?
Has he looked at the numbers?
Back in 1996 I agreed with Greenspan. I worried too that the market was overvalued. We thought this for a bunch of reasons. We were wrong.
Why does the fact that our worries were wrong then make Cochrane's worries right now?
They made fun of Shiller when he said in 2005 that house prices looked awfully high, and they went up for a few more years. Greek interest rates were really low in 2007…
I gotta interrupt again: Who are the "they" who were making fun of Shiller when he said that house prices looked awfully high and that expected returns from housing were negative as it looked like the housing bubble would collapse over the medium term? Was one of them John Cochrane, denying that expected returns on a positive-beta asset like housing could ever be negative?
The facts don’t support the theory that prices are high because people always expect a “greater fool” to pay a still higher price…. The “irrational” camp points to puzzling surveys…. But surveys are easy to misinterpret: “Expect” and “risk” in casual conversation have very different meanings than “conditional mean and variance” in our models. And economics was meant to explain behavior, not self-perception. Rats in mazes do a good job of obeying the laws of economics, but they’re not so good at responding to surveys…. [M]arket swings are all about financial frictions, not mass risk aversion or psychology…. [V]ariation in price ratios corresponds to discount-rate variation, not to changes in expected cash flows or the ability to find a greater fool. The challenge is to understand that discount-rate variation. A focused debate, based on clear facts and explicit theories, is real progress.
If Cochrane now agrees with Shiller ca. 2005 on the housing bubble, and repudiates his claim from two years ago that "the facts don’t support the theory that prices are high because people always expect a 'greater fool'", then he should say so more clearly. And do note that, from my perspective at least, Cochrane is simply incoherent: what Cochrane calls "discount-rate variation" is not an alternative to expecting ex ante to find a greater fool and failing ex post, rather, what Cochrane calls "discount-rate variation" is a subclass of when people ex ante expect to find a greater fool and fail ex post.
The Federal Government has about $15 trillion of formal Federal debt outstanding. It has uncountable trillions more unfunded promises and credit guarantees. Right now it takes in about $1.5 trillion and spends about $3 trillion a year. We must, by arithmetic, either pay off this debt, default on it, or inflate it away…. The only hope for paying it off is to return promptly to strong long-run growth, and to reform entitlements. Doubling Federal revenues by raising income tax rates on "the rich," or by cutting discretionary spending by more than $1.5 trillion per year, forever, seem unlikely. That's arithmetic too.
But Cochrane's arithmetic is fake.
As he was writing, the nominal debt was growing not by $1.5 trillion/year but by $1.0 trillion/year. The amount of excess debt being issued over what was sustainable at a constant debt-to-annual GDP ratio was $500 billion/year. Of that, $300 billion/year was a transitory cyclical component caused by the depressed economy. The numbers he was putting out were more than seven times the size of the real numbers--that's the real arithmetic. And forecasts then were for a debt-to-annual-GDP ratio stabilizing for the rest of the 2010s even without large additional policy change. That was the real arithmetic. Not a $1.5 trillion/year gap, but a $200 billion/year gap, or less.
But Cochrane, apparently, did not look at the numbers.
He did not know the real arithmetic of the debt and the deficit.
And so he wrote:
I'm not optimistic. Growth economics is unanimous: You get such growth only from higher productivity, and from letting new innovative competitors dethrone established interests. That's not where our economy is going. Keynesian stimulus doesn't give 10 or 20 years of sustained growth, even in Krugman's "model."… I happen to dislike inflation. Krugman and DeLong are all for it…
I am? I note no citations from Cochrane to anything I have ever said or written here.
They must have been smoking better weed in the 1970s. But I notice that lots of people seem to agree with them. So, it seems to me that inflate it away, and print money to pay the bills, remains a decent possibility. That's arithmetic. I wonder which part of arithmetic Krugman would have me abandon.
What Chicago does "know" is scholarship. DeLong cites a transcription from discussion at a long ago conference…. At Chicago, we take a little time to research what people actually have to say before calling them… less than "half-intelligent" (DeLong). You know what I think of that. Why you continue to read these guys is a mystery to me…
Let's roll the videotape, from March 2009: John Cochrane:
[T]he danger now is inflation. And I would say it's a greater danger than most of the other people 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….
The system is much more resilient than it was because of deregulation. Back in the Great Depression… if the Bailey Savings and Loan goes under, there is no way that JP Morgan, financed by an equity infusion from the sovereign wealth fund of Kuwait can come in and take over and start lending. You're just stuck. Well, we're not in that situation anymore….
Policy is chaotic. Who would invest in this climate? It's not about toxic assets; it's about who wants to go in on a deal with Darth Vadar [sic], who can change his mind at any moment? That's the uncertainty that's keeping things from getting going and that's what's slowing the rebuilding of financial markets. We're facing growth-destroying marginal tax rates, an excuse for the government takeover of large and completely unrelated sectors, class warfare, vindictive ex post taxations….
My great hope is that the bounce-back will be quick before the quack medicine can be said to have worked. (Chuckles.) Just as we sort of -- as people think that this insane idea of fiscal stimulus -- which I'll go on with later if I get a chance -- came from Roosevelt's experience with no reason why it should work, there is a danger of thinking all of the crazy stuff they're doing now will have caused the bounce-back…
I quote four paragraphs. I snark. And Cochrane counter-snarks, complaining that I did not "research what... [he] actually had to say"?
If what Cochrane is saying with his "what Chicago does 'know' is scholarship… research what people actually have to say before calling them… less than 'half-intelligent'" is that he repudiates his March 2009 presentation at the ill-done Council on Foreign Relations conference, I would welcome that and agree: It was very ill-done. He said an awful lot of things that were simply wrong and confused in a very short space.
But, if that is indeed what he is doing, he needs to be more explicit.
I view inflation is a danger, not a forecast. The popping of "bubbles" is hard to predict. We're sitting on an earthquake fault. When or if it goes is anyone's guess. I also pointed out that inflation can come quickly, as it surprised the Keyensians [sic] of the 1970s, and as its quick disappearance surprised them again in the 1980s when the US returned to growth-oriented policies.
Again: it took 8 years and one huge oil shock for expected inflation to rise from 1966's 2% to 1974's 5%, and 14 years and two huge oil shocks for it to breach 10%--if that is what Cochrane means by "quickly", that come 2027 we ought to have done something to get our long-run fiscal house in order, I would certainly agree. And I would point out that perhaps we already have--if the ACA implementation proceeds as we hope, we will come 2027 find that we have no long-run budget problem. If "we have until the mid-2020s is what Cochrane means by "quickly", he needs to say so--and I would agree.
And again: the reduction in expected inflation from 9% in 1981 to 5% by 1985 was, given the size of the 1982 recession, about what the standard forecasting models of the time were predicting. Who are the "Keynesians" who were surprised by this? Cochrane doesn't say--interesting citation practices once again…
Cochrane concludes with:
You can't repeal arithmetic. That which is unsustainable cannot last.
I wish I could agree.
It would be very nice of what was unsustainable could not last.
It would be very nice if false prediction followed by doubling down and repeating false predictions led to some kind of intellectual bankruptcy, followed by some form of liquidation/takeover process--or at least a rebalancing. I know that I have been surprised by a number of things over the past five years (most notably how very resistant to any form of downward movement nominal wages have turned out to be), and I have tried to mark my beliefs to market: moving from 5% Austrian, 5% RBC, 30% Keynesian, 60% monetarist to 1% Austrian, 1% RBC, 70% Keynesian, 28% monetarist.
But I think John Stuart Mill had the decisive counter:
What was affirmed by Cicero of all things with which philosophy is conversant, may be asserted without scruple of the subject of political economy--that there is no opinion so absurd as not to have been maintained by some person of reputation. There even appears to be on this subject a peculiar tenacity of error--a perpetual principle of resuscitation in slain absurdity…