Money Magnetism: Effortless Attraction In Canada – John Cochrane is a Rose-Marie and Jack Anderson Senior Fellow at the Institute of Economics and author of the new book, The Financial Theory of the Price Level.
In this wide-ranging conversation, Cochrane discusses the causes of inflation, what we can (and can’t) do about it, the economists who influenced his thinking, and how his father inspired him to become an academic.
Money Magnetism: Effortless Attraction In Canada
Last year’s inflation rate was 8%. This means we have to pay more at the gas station. This means we have to pay more at the grocery store. This is eating into our economies. And inflation is still hanging over us right now, at about 6…between 6 and 7 percent while we’re filming this show. Where does inflation come from and what can we do about it? Economist John Cochrane talks about today’s common knowledge.
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Welcome to extraordinary knowledge. My name is Peter Robinson. John Cochrane, who holds a bachelor’s degree in physics from MIT and a doctorate in economics from the University of California at Berkeley, served on the staff of the White House Council of Economic Advisers during the Reagan era. Dr. Cochrane then began his academic career in earnest, joining the economics faculty of the University of Chicago and then the faculty of the Booth School of Business, Chicago. For about seven years now, Dr. Cochrane has been a graduate student at the Stanford Institute. Today, John Cochrane published his wonderful essay, “The Financial Theory of the Price Level.” Financial theory includes many equations. “Fear not,” John writes in the introduction, “you don’t need to do more economics or math than is taught in a good undergraduate economics course to understand everything. “We’re going to test it. Jean, welcome.
That’s right, your new book, there are two quotes. Milton Friedman in 1963, “Inflation is always and everywhere “a monetary phenomenon”, in the sense that it is “and can only be produced” by a rapid increase in the quantity of “more money”. Price Level Theory, “In this book I argue that financial theory is a ‘truly new theory’ not based on monetary economics.” So brave, John. And you began your career in the economics department at the University of Chicago, where Milton Friedman worked. George Stigler, Gary Becker, these great economists who gave us the school of finance, this great revolutionary innovation in the economic discipline in the middle of the last century, and now you come along and say they’re wrong. What are you saying? What are you arguing about?
Hey man, am I excited to get behind the keyboard? They are 90% right. And you can see, in fact, the magic of academic cross-fertilization “makes me very Chicago, and I’m very lucky to be here” because my instincts are Chicago. But I still learned a lot from my time at Berkeley and my skepticism about money. So let’s get straight to it. Where are they right and what am I saying that is a little different? I agree, monetary theory agrees with standard monetary theory. According to Milton’s famous quote, “If you drop money from a helicopter, you will experience inflation.” In fact, our government could just drop money from helicopters and voilà, we would have inflation. We all agree, this will cause inflation. Well, that’s a good thing, because we see similar things around the world anyway, but financial well-being theory focuses on public debt, which includes the extent to which people believe that our government will give back. inflation, and the money is just another form of public debt, so now we are faced with it.
The money, if I can get technical for a minute, is very short-term, interest-free public debt. And in fact, most of the money currently held in reserve by the Fed is interest paid to pay down the government debt. There is no big difference between government money and debt. So where do Milton and I disagree? If we could just pick it up and bring it here, it would be a better show. The central question is that of the bond exchange. So if we throw money away, everyone will use it and you will have inflation. If we abandon bonds, people will spend and we will have inflation. But the idea of the central donors is that I give you money but I get back the same amount of government bonds. Now are you going to go out and spend? I can give you $10,000, you’ll leave the show and you’ll spend it. But if I give you 10 and I take back 10 government bonds, you have more money but you no longer have wealth. Now are you going to run out and use it? Ah! This is the most important test of an idea. I would say that with the first level, without all the friction and other things that matter at the second level in the real world, there would be no inflationary effect. As a real financier says: “Yes, give you money”, but getting the deposit back is like giving yourself money.
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No, no, no, no, because… No, I’m a little surprised because I really thought I was following this. During this conversation, I had a number ready in mind, John.
Milton would therefore say that there is a difference…there must be. You can’t write a book this heavy on semantics. There must be something more than defining money in a slightly different way.
Oh yes, a lot. Its economic base is very different. In one case, this is what we call the “elemental effect.” The problem is you have too much money and not enough bonds, so you try to solve that problem, and that’s standard monetary theory. In my case what matters is the total amount plus the total deposit amount. So, the wealth effect versus the stock composition effect. It’s a different economy, it’s not a question of semantics.
Are bank deposits important? Financial theory says that if we look at government debt, it’s like federal securities. So what matters is how much they spend relative to taxes, minus what spending the government can use to pay down the debt. However, according to this view, all that matters is government money. If the government has issued money and people believe in it, I lend it to you, I write an IOU, I owe it to you, Peter, I give it to you, it’s called internal money. The government has nothing to do with it. I just lent it to you. I created liquidity. Does this cause inflation? So the financiers will say yes.
Modern Monetary Theory (mmt): Definition, History, And Principles
Well, it’s not… If I write you an IOU, I write you an IOU, right? Do I owe you $1? From a standard perspective, I just have money, you can go give it to someone else and it helps your business. This is inflation in standard Milton Friedman terminology. Meanwhile, from a financial theory perspective, again, in the simplest view, it’s like an option, like a private contract on anything else, but the government doesn’t have to bet on this tax. It’s not the government’s responsibility, it’s my responsibility. This is not supported by a government surplus, so it does not affect price levels. So there is a big difference. Should the government stop and monitor the amount of liquid assets we all take for granted? Do these things cause inflation? And I’ll quickly add, before you add another question, that this is what makes budgetary theory so relevant today. and monetarism and maybe only relevant to 1935, or even 1964, but we have a very bad monetary system with things like that. Pension contracts, liquidity of all kinds.
Cryptocurrencies are a great example of this. The government, our Fed, is not trying to control the country’s money supply. No more need for reserves. M2 is everything people want. So the idea…luckily we’re not looking at restricting things like that to limit inflation because the Fed doesn’t limit it. We need a theory that corresponds to today’s institutional realities. One of them is the target interest rate. Our government does not limit the amount but sets interest rate targets. Milton Friedman said the interest rate target was about to go down and it was impossible. The amount must be limited. They do not limit the amount. And they don’t limit the amount inside. We are therefore not in a situation where monetarism can work.
And they don’t try to follow… it’s called internal money, they don’t try to follow the money
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