John Cochrane is a man on many missions.
Let’s start with his groundbreaking book, The Fiscal Theory of the Price Level, which put fiscal policy in the spotlight as a cause for inflation, more than monetary policy, and continues to spur debate. And now we are looking to see how he challenges prevailing exchange rate theory as he applies his unique perspective to age-old economic issues in his coming book, Fixing the Euro.
John uses his platform as Senjor Fellow at Hoover to help put together panels and events available to the public that bring many scholars and practitioners together to discuss and debate topics that have driven the economy in the past present and future - from debates on the Federal Reserve and global central bank policies to the “Panel on Tariffs” he led two weeks ago. (Find it online. Agree or not there’s lots of information and views to hear.)
Then there’s John as “The Grumpy Economist” with his blog of the same name that has morphed into his Substack. “This is a blog of news, views, and commentary, from a humorous free-market point of view,” he explains. “After one too many rants at the dinner table, my kids called me "the grumpy economist," and hence this blog and its title.”
Right now, he has been along with so many of his colleagues at Hoover, channeling his passion into putting together the conference this week that honors one of the biggest stars of modern economic theory, their colleague and friend, the author of the Taylor Rule in “A Celebration in Honor of John Taylor.”
John reminds us that everyone can listen online this week and view it on their website in just a few days. And that the program for Hoover’s companion annual event on the big challenges for monetary policy, which follows on the day after Taylor’s, is looking at “Finishing the Job and New Challenges.”
So dive in an hear what John has to say. He is adamant that tariffs are antithetical to free trade and ultimatelty will we be unequivocally bad for the U.S and global economy. He supports the FOMC’s decision this week to stand pat for now and see how tariff turbulene plays out. At the same time he is urging Chair Powell to stay data dependent in determining where the Fed goes next on rates and when.
And above all hear what he has to say about Professor Taylor and his Rule, the impact he has made not only on economics but also on all those he has worked with over the years. For many at Hoover and in the profession, he is nothing sort of an economics hero, who has made his mark not only in theory, but also in practice.
John Cochrane: a busy man with a new book- 00:00:58:13
if you mind me advertising, I have a new book coming out. All right. Crisis cycle with Lewis Okano and Klaus Marzouk about the euro and how to fix the euro. Well, I think we have the answers. Will they listen to us?
Are tariffs the Fed’s next big challenge? 00:01:45:06
Chair Powell? Wise man. And I hope the Fed would learn that its own forecasts are very unreliable, as are everybody else's forecasts. So thinking, you know, what's going to happen in the future is probably not a good idea. Getting ready to react quickly once bad things happen is a good idea. So that's why he said something very interesting, that there are risks right now. I won't get the quote right. Basically, tariffs threaten stagflation, the prices go up and the productive capacity of the economy goes down. So you're faced, as the Fed with both inflation and unemployment going up. And he kind of said, we're doing nothing, not because nothing's happening, but because we've got threats on both sides here. I think if the tariffs keep going the way they are, that will the next big challenge for the Fed.
Is inflation or recession the greater tariff risk? 00:02:57:12
Well, both… a pregnant pause. Now, there's the question, what's the bigger threat… and what can you do about it? The Fed is faced with a real conundrum that there's inflationary forces and there's recessionary forces, if you will. Let's add to that. I don't think that there's much that interest rates can do in the face of a supply shock, which is what tariffs are. Tariffs are a shock that raises prices and also reduces the productive capacity of the economy. I think I said that already, but that's what we mean by supply shock. There is less productive capacity, and so by lowering interest rates, you increase demand. But when the problem is low supply, <in the face of> increasing demand. You can't build more houses by increasing demand. You need the supply in to build. You know, to get to get more output. Now, here, I don't think the Fed sees things quite this way. The Fed really always kind of believes in demand, but, well, I shouldn't. I shouldn't say that.
The real risk is a Fed that cannot raise interest rates- 00:04:30:22
Congress would be up in arms by any raising of interest rates. The deficit is already bad, raising interest rates raises interest costs on the debt. So they're going to face enormous pressures not to raise interest rates. And I think the real scenario is a repeat of 1979, 1979. Now we're old enough to remember 1979. Yeah. Recall there was a wave of inflation in 1976 that hit about 10%. Where have I seen that before? Went sort of away. It's still bubbled along. Right. And then a supply shock hit the second big oil crisis. The Fed was faced with, well, do we fight the inflation or fight the unemployment? They did a little bit of both. They actually raised rates, but not fast enough. Most people think we got stagflation and then we got the huge recessions of 1980 and 1982. It was very difficult politically, economically, all the rest of it. That, I think, is the nightmare scenario for the Fed. Hmm. Let's hope the tariffs don't kick in and cause that much damage….
Why Tariffs? The policy question with five answers 00:06:33:19
You ask them, why are you doing tariffs? And it's about five answers. Raising revenue, bringing back manufacturing, punishing our enemies, national security, trying to force people to do stuff we want to do. You know, which one is it these today? Somewhere in those questions, one can find reasons that some tariffs might sometimes be beneficial, but it's very hard to make sense of our current tariff policy.
The myth of the desired factory job 00:09:04:17
Let's say, you know, there's this story about the hollowed out Midwest and the people who don't have jobs and so forth. 4% unemployment rate are higher, a very high level of unfilled vacancies. Lots of companies say we want to bring manufacturing back to the U.S. We can't find the workers because advanced manufacturing in the U.S. needs skilled workers and it needs workers at all. Did I say 4% unemployment rate? Yes! You know, there is just not this vast army of people in the U.S. who are willing to work long hours at hard manual labor for whatever wages make it possible. And there are not people in the U.S. even if you could find people who want to spend all day long screwing in iPhones, they're not people in the U.S. who want to buy iPhones for $5,000.
Back to the Question…why tariffs? 00:10:07:05
Because whether or not we have tariffs, that seems to be an issue that is hanging over us. Yes. So one of the questions, the you know, the tariffs is answer in search of the question. One of the question is, oh, we're going to lift up manufacturing in the U.S. at very large cost. The other question is, oh, the trade deficit, the budget deficit, the overall deficit problem.
The role of US Current Account deficits- 00:10:32:09
So this is a nice piece of economics when we when the Chinese you'll play China, you send me some stuff, you work harder, the sweatshop, you send me some stuff on eBay. Okay. I give you pieces of paper. Yeah. That's actually a pretty good deal, isn't it? We can print paper a lot cheaper than they can send us stuff, but unfortunately, they're not willing to sit on that paper. That's right. What does a Chinese person do with dollars? Well, the government often buys Treasury securities. Yeah, exactly. So the Chinese person, the only thing dollars are good for in the world is to buy stuff from the US, either now or later. Okay. China doesn't want the stuff now. It wants it later. So it uses those dollars to buy Treasury securities. Well, some people say we're a very consumptive country that doesn't need to be as consumptive as it is. Well, we may well get our wish…
Monetary Policy, John Taylor, the Taylor Rule- 00:13:49:
if inflation goes up, raise interest rates more than one for one, with inflation to drive inflation back down. But also, if unemployment goes up, you're allowed to lower interest rates in order to fight the unemployment. And that will stabilize the business cycle as well as stabilize inflation. John noticed this. It started empirically. John noticed that this was a characteristic of good times. So in the 1970s, the Fed wasn't raising interest rates very fast as it moved to the 1980s. It responded more quickly to inflation. Aha. So he just noticed that, hey, there's a interesting empirical pattern. Gradually it fit into economic theory that this was indeed a very good thing. Many different theories behave very well under a Taylor Rule. But I want to emphasize one of John's central contributions is not equations and economic theory. He brought this to reality, to the real world. He made it into a practical way for central banks to operate. Among other things, he does not advocate a fixed rule. Don't replace the Fed with a computer.
Taylor’s view of the Taylor rule 00:14:55:06
Taylor says. Look, this is the simple first step. It's a guidepost. It's a way to make sure your decisions are consistent over time and you don't get too excited or too depressed. You start with that as a benchmark. Something happens. Well, what is the Taylor will say that, you know, says whatever we should do now, let's think, do we really want to do that right now? And if not, let's explain not why we're doing what we're doing, but let's explain why we are deviating from the. TAYLOR Well, yes. So maybe there's a financial crisis. Well, if you're going to deviate from the Taylor Rule, because there's a financial crisis on, but that helps you to bring consistency with flexibility. And that's Taylor's central contribution. So he made it so easy for so many of us in a way, you know, I mean, it just but then that but that's the deviation part, I guess, is the tough part, because we've got to right now and people don't know what how far they're going to go.
Covid and the Taylor Rule and more!- 00:16:22:03
So, inflation broke out and the Fed did nothing. It sat on its hands for a full year. The Fed has never done that because it's forecast said it was transitory and it would go away and so forth. A Taylor rule would have said let's react quickly. I don't know where this inflation is coming from. Maybe it's transitory, maybe not. But let's get moving quickly. So that would be a case we're paying a little more attention to. The Taylor Rule might have gotten the Fed to react more quickly and not have the inflation breakout. On the other hand, during the pandemic, unemployment went to 25%. So if you followed the Taylor rule, the Fed should have created immense amounts. Now, I think that's a case where you say, wait a minute, this is a rule that works during normal recessions. We have something very different. It is not appropriate to fight the pandemic unemployment because in the pandemic unemployment was high because the stores are locked down.
Taylor rule exceptions- 00:19:11:10
The Taylor Rule also presumes that you don't want inflation and that inflation is controllable by the Fed. And there are extreme times, like in a war where you might actually want some inflation, you want inflation to inflate away some of the government debt so that you don't have to raise taxes to pay the war. And governments do that. And I think that's some of what happened during COPE, and I think some of it was wittingly or unwittingly deliberate. We're going to spend a lot of money and we're going to take it out of the bond holders by inflating. Oh, well, there's a lot of questions now. What's going to happen to bond holders under President Trump and Scott Vincent, the Treasury secretary?
Fed’s Framework reviews past Vs future 00:21:24:10
A lot of what the last framework review did was for the Fed promised If we undershoot and there's not much inflation, we will then overshoot to bring the level of prices back, but only in that one direction. And their idea was that promising inflation in the future would add stimulus now and help avoid the specter of deflation. I'm not quite sure if that ever existed, but anyway, that's what the thought was. But, of course, now inflation is a problem. Supply shocks are the problem, not zero bound deflation. It's a totally different problem. So what are they going to do now? As I see in the tea leaves and they have a research conference coming and the kind of things they're asking, unfortunately, I think they are going to be tempted to simply change some adjectives here and there to focus on communiques and expectations management and leave something pretty vague and one that does not confront what they should be confronting.
Last Framework issues… 00:22:25:07
What went wrong and what do we do about it? We had nine, 10% inflation. Your target was do something went terribly wrong. What went wrong and how do we fix that? That's what the strategy review should be. I don't think it's going to be that because nobody in Washington these days can say, Boy, we screwed up. We've got to really fix this. You have to say, Oh, it was wonderful. And now we're just going to see on some adjectives. Well, remember at the beginning of the coming of a pandemic and inflation, the inflation rate had come down and many people said, oh, you know, why are people so bothered about inflation? Now? It's only a down to 4%, three and a half percent.
When a 2% target does not produce a 2% result 00:23:44:22
Even though inflation is back to where it's back to where it started, the Fed and the ECB and the other central banks, you will be surprised to learn they were tasked with price stability. And the way they interpreted this is we want 2% inflation looking forward. And if we ever screw up, we'll just forget about that and just do 2% inflation going forward once we've brought it back to two job done. Well, people are really mad about every couple of years, boom, prices go up 20%, but inflation then is 2% going forward. Yeah. So I think one of the big lessons of this experience and the one that would be very helpful going into the next supply shock is that they should do it symmetrically. As they said, if we if we go under, we'll bring it back.
Nuances of the Fed’s goal-‘Price stability’ 00:26:17:11
Get out of the what's the economic outlook up or down 20 basis points. And let's think about these big questions. How do we do it? So Congress said price stability, that's your mandate. The Fed then gets to interpret price stability. And there was historically and there I think is going to be now a big debate about what does that mean? Price stability could mean the level of prices, it might go up, might go down, but we bring it back to where it was. The Fed chose to interpret price stability as 2% inflation. Well, even with 2% inflation, there's lots of ways we could interpret that. The Fed and the European Central Bank interpret 2% inflation to mean we will do things to try to bring us back to 2% inflation. Greenspan did say he wanted to get back to zero inflation and even ‘price level stability.’ He didn't want to push their hard, but given a chance, if inflation came out too low, he'd say, fine, where's the fire? If inflation is half a percent or 1%? The Fed and the ECB, after the financial crisis, decided that too low inflation was a fire. So 1.5%, 1.7%, inflation when they had set a target of 2%, this, oh, we've got to do something. Quantitative easing. Yeah. As opposed to Greenspan, who would have gradually accepted going back down to zero. I think that was a good idea because I don't believe in the danger of a deflationary spiral.
Fiscal Theory of the price level 00:29:15:03
The fiscal theory fundamentally says that fiscal and monetary policy are linked and that if fiscal policy demands that we print money to cover deficits, then there's going to be inflation no matter what the Fed wants to do about it. So they're linked. It doesn't mean the Fed is powerless. The Fed has great power to guide inflation with interest rates, but not complete, especially when deficits are in problem. RIght now the most salient effect that fiscal theory points out is that if the Fed raises interest rates to try to lower inflation, that raises interest costs on the debt. Well, that's we all understand the deficits sort of are a danger to inflation so that there's an inflationary force fighting whatever disinflationary forces that monetary policy is. There's another one. If the Fed raises interest rates, that's going to soften the economy. That's the whole point. So that means you get more <AUTOMATIC> stimulus, more unemployment insurance, more deficits just because of the recession. Well, deficits are inflationary. So in every economic model, not just fiscal theory, for the Fed to lower inflation by raising interest rates, it needs fiscal policy to come along and pay the interest costs on the debt and pay for the extra deficits and so forth.
The Hoover Conferences-00:30:55:02
Yes. Oh, yes. We have two wonderful events. They will be livestreamed. They will be available online after the fact. They will also be we're going to produce books with written versions of the comments. Those will go online a couple of weeks afterwards and then available pretty much for free or cheap from Hoover Institution. Press one. It's all done. Two separate books, one for John Taylor and one for the Monetary Policy Conference as one of the coordinate organizers with Mike Bordo. I think it's going to be a smashing hitt. We've got a wonderful set of people coming, including many Federal Reserve Bank presidents and FOMC members who are coming. And we've instructed everybody, think about the big issues. It's not going to be one more, you know, D.C. or New York up or down next week. What is the bond market say It's going to be? Everybody, give us your your your big issue, your structural problem. What's the big problem? Nobody's thinking about that. That's their charge. And given the amazing quality of the people we have coming, I think it's going to be very interesting.
John H. Cochrane is the Rose-Marie and Jack Anderson Senior Fellow of the Hoover Institution at Stanford University.
His monetary economics publications include the book The Fiscal Theory of the Price Level and articles on monetary policy and inflation. His finance publications include the book Asset Pricing and articles on dynamics in stock and bond markets, the volatility of exchange rates, the term structure of interest rates, the returns to venture capital, liquidity premiums in stock prices, the relation between stock prices and business cycles, and option pricing. He has also written articles on macroeconomics, health insurance, time-series econometrics, financial regulation, and other topics. He was a coauthor of The Squam Lake Report. He writes occasional Op-eds, mostly in the Wall Street Journal, and blogs as “the Grumpy Economist” at grumpy-economist.com. He recently created the Coursera online course “Asset Pricing.”
Cochrane is also a Senior Fellow of the Stanford Institute for Economic Policy Research (SIEPR), Professor of Finance and Economics (by Courtesy) at Stanford GSB, a Research Associate of the National Bureau of Economic Research, and an Adjunct Scholar of the CATO Institute. He is a past President and Fellow of the American Finance Association, and a Fellow of the Econometric Society. He has been an Editor of the Journal of Political Economy, and associate editor of several journals including the Journal of Monetary Economics, Journal of Business, and Journal of Economic Dynamics and Control. He was a director of the NBER asset pricing program. Awards include the Bradley Prize, the APEE Adam Smith award, the TIAA-CREF Institute Paul A. Samuelson Award for Asset Pricing, the Chookaszian Endowed Risk Management Prize, the Faculty Excellence Award for MBA teaching and the McKinsey Award for Outstanding Teaching.
Before coming to Hoover, Cochrane was the AQR Capital Management Distinguished Service Professor of Finance at the University of Chicago Booth School of Business, where he taught the MBA class “Advanced Investments” and a variety of PhD classes in Asset Pricing and Monetary Economics. Cochrane earned a Bachelor’s degree in Physics at MIT, and earned his Ph.D. in Economics at the University of California at Berkeley. He was at the Economics Department of the University of Chicago before joining the Booth School in 1994, and visited UCLA Anderson School of Management in 2000-2001.
Outside of academic pursuits Cochrane is a competition sailplane pilot, and enjoys cycling, windsurfing, skiing, and other outdoor activities.
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