John Cochrane argues that fiscal theory can explain both the period of low inflation and the return of rapidly rising prices after the pandemic. But it offers limited guidance to policymakers beyond what is already well-known
Save time by listening to our audio articles as you multitaskA wonkish theory, laid out in glorious detail in a new book by John Cochrane of Stanford University’s Hoover Institution, would offer a potential explanation. “The Fiscal Theory of the Price Level” builds a theory of inflation as ambitious as that proposed by John Maynard Keynes’s “The General Theory” or Milton Friedman’s and Anna Schwartz’s “A Monetary History”.
Mr Cochrane is careful to note that the adjustment of the price level is not instantaneous. People can be poor judges of a government’s credibility when it comes to paying off debts. Just like stocks, prices are able to deviate from fundamentals. Yet in the long run, they adjust. A government that hands out money without eventually running surpluses will not avoid inflation for ever.
Mr Cochrane also brings fiscal theory to bear on America’s inflation in the 1970s-80s. In the mid-1970s price rises exceeded 12%. The Federal Reserve lifted interest rates; inflation dropped to 5% by 1977. Yet Mr Cochrane points out that inflation shot up again to more than 14% by 1980, in part because America failed to get its fiscal house in order.
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