- Independence has increasingly come under pressure and this pressure will remain. What has been tried and tested for years is now questioned again.
- Increasing demands on central banks reflect the failure of other state organs.
A conference at the University of Chicago’s Becker Friedman Institute addressed the status of the Fiscal Theory of the Price Level and the theory’s implications for current policy. Slides and papers are available on the conference website. Given that the conference was meant to resuscitate research on the FTPL and that the participants were selected accordingly, many contributions appear rather mainstream.
Chris Sims worries about indeterminacy of the price level if monetary policy is constrained by the ZLB and fiscal policy is passive.
The key thing here is that the central bank determines prices and inflation without any fiscal support. If the idea you got from the FTPL is that fiscal policy is necessary to determine the price level and inflation, that’s not correct. …
So, the conclusions are:
- FTPL forces us to think seriously about fiscal/monetary interaction, and that’s very important. But fiscal support is not necessary for monetary policy to work, nor is it useful to think of fiscal policy determining inflation on its own – the central bank can indeed be independent.
- Fiscal/monetary interaction becomes really important when we start thinking about the liquidity properties of government debt.
- Helicopter drops? Forget it. This is not some cure-all for a low-inflation problem.
- QE can be harmful, as it soaks up useful collateral and replaces it with inferior assets.
- Neo-Fisherian denial is not good for you. Central banks that want to increase inflation need to increase nominal interest rates.
John Cochrane argues that to get the cyclical properties of inflation “right” one should focus on the discount factor in the core FTPL equation, not the primary government surplus. The discount factor might also be affected by monetary policy. See also his blog post.
Harald Uhlig remains very skeptical and points to the lack of evidence favoring the FTPL. On his first slide, he asks:
- What does FTPL want to be?
– A theory that can be consistent with the data? OK
– An equation needed to complete a system? OK
– A theoretical or extreme possibility? OK
– A set of predictions, which occasionally work in exotic circumstances (“Brazil”)? PERHAPS
– A set of predictions, which help often (“Taylor coeff < 1”)? ?
– A useful framework for practitioners? ?
– The miracle cure for the failures of other inflation theories? ?
– A framework for the key interplay of fiscal and monetary policy? ?
- Where is the “smoking gun”? What set of facts “scream” FTPL? Specific predictions?
- Why is sovereign default off the table? Sure, a central bank can accommodate by inflating away debt … is that all?
- The US, Japan, the Eurozone have a near-deflation problem (is it?). Do you advocate “irresponsible” fiscal policies to solve this?
- What advice would you give the sunspot-branch of macro?
In his FT blog, Larry Summers argues for a “quite radical” change in government debt-management. He proposes several lessons:
- “Debt management is too important to leave to Federal debt managers and certainly to leave to the dealer community. … when interest rates are near zero, it has direct implications for monetary and fiscal policy and economic performance … and … financial stability.”
- “… it is fairly crazy for the Fed and Treasury, which are supposed to serve the national interest, to pursue diametrically opposed debt-management policies. This is what has happened in recent years, with the Fed seeking to shorten outstanding maturities and the Treasury seeking to term them out.”
- “Standard discussions of quantitative easing … are intellectually incoherent. It is the total impact of government activities on the stock of debt that the public must hold that should impact on financial markets.”
- In the US, “the quantity of long-term debt that the markets had to absorb in recent years was well above, rather than below, normal. This suggests that if QE was important in reducing rates or raising asset values it was because of signalling effects … not because of the direct effect of Fed purchases.”
- “The standard mantra that federal debt-management policies should seek to minimise government borrowing costs is … wrong and incomplete. … it is risk-adjusted expected costs that should be considered. … it is hard to see why the effects of debt policies on levels of demand and on financial stability should be ignored.”
- “The tax-smoothing aspect, which is central to academic theories of debt policy, is of trivial significance.”
- Rather than providing opportunities for carry trade, “[t]reasury should reverse the trend towards terming out the debt. Issuing shorter term debt would also help meet private demands for liquid short-term instruments without encouraging risky structures such as banks engaged in maturity transformation.”
- “Institutional mechanisms should be found to insure that in the future the Fed and Treasury are not pushing debt durations in opposite directions.”