Stevenson and Wolfers: “Is Paul Ryan an Inflation Nutter?”

Additional evidence addressing the question asked by Betsey Stevenson and Justin Wolfers.


It’s a fair question when you read the introduction to the House budget:

…Unless we act, by 2023, we will add another $8.2 trillion to our national debt. That debt will weigh down our country like an anchor.


Unless we change course, we will have a debt crisis. Pressed for cash, the government will take the easy way out: It will crank up the printing presses. The final stage of this intergenerational theft will be the debasement of our currency. Government will cheat us of our just rewards. Our finances will collapse. The economy will stall. The safety net will unravel. And the most vulnerable will suffer.

So, not Greece, but Weimar Republic.


Market Expectations and Survey Data


Stevenson and Wolfers cite market based evidence that suggests little chance of high inflation, as Representative Ryan fears. They write of Representative Ryan’s forecast that it is:

So shaky, in fact, that either Ryan is being dishonest or he’s placed himself on the Spam-hoarding radical fringe, far outside any standard approach to monetary economics.

Who am I to disagree? (See [1] [2] [3] [4]) Here I provide some additional evidence to buttress their assertion.


First, the breakeven inflation rates from Treasurys and TIPS, and the survey based expectations, they mention.


nutters1.gif

Figure 1: Expected inflation implied by ten year constant maturity yields minus TIPS yields (red), and five year (blue); March data for 3/12. Mean expected ten year inflation from Survey of Professional Forecasters data (green inverted triangles). Source: St. Louis Fed FRED, Federal Reserve Bank of Philadelphia.

Implied inflation from bond yields suggest inflation over the next ten years averaging less than 2.6% as of 3/12, and over the next five years less than 2.3%. Survey data from the Philadelphia Fed SPF confirm the absence of high expected inflation: 2.3% as of mid-February.


Since long term nominal interest rates arguably incorporate an inflation premium, one can’t necessarily read expected inflation off of the gap between Treasurys and TIPS. Haubrich, et al (2008) have developed a methodology to extract the pure expected inflation component from inflation swaps:


nutters2.gif

Source: Federal Reserve Bank of Cleveland.

Learning from History: Inflation in Prolonged Periods of Slack


The last reason that one should not fear high inflation relies upon observations of the behavior of inflation during periods of high slack – or persistent and large output gaps (PLOGS). From Andre Meier, in Still Minding the Gap:

This paper studies inflation dynamics during 25 historical episodes in advanced economies where output remained well below potential for an extended period. We find that such episodes generally brought about significant disinflation, underpinned by weak labor markets, slowing wage growth, and, in many cases, falling oil prices. Indeed, inflation declined by about the same fraction of the initial inflation rate across episodes. That said, disinflation has tended to taper off at very low positive inflation rates, arguably reflecting downward nominal rigidities and well-anchored inflation expectations. Temporary inflation increases during episodes were, in turn, systematically related to currency depreciation or higher oil prices. Overall, the historical patterns suggest little upside inflation risk in advanced economies facing the prospect of persistent large output gaps.

This point is highlighted in Figure 3 from the paper.


meier1.gif

Figure 3 from Meier (2010).

The author defines an episode of persistent large output gap (PLOG) as at least eight consecutive quarters of negative output gaps greater than 1.5 percent in absolute terms. The October 2012 IMF World Economic Outlook indicates the 2013 US output gap of -4.0% of GDP represents a decline (in absolute terms) from -5.6% in 2009, so the US clearly fits the bill for continued low inflation.


Concluding Thoughts


Market based and survey based data indicate stable inflation expectations. Historical experience also suggests that inflation will remain low. However, history has never been an impediment to a faith-based view of economics. [5]


My one quibble with the Stevenson and Wolfers article: What’s so bad about hoarding spam?.

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42 thoughts on “Stevenson and Wolfers: “Is Paul Ryan an Inflation Nutter?”

  1. tj

    To be fair, this claim of Ryan is slightly different than in the past. IIRC, he implied that QE would lead to inflation.
    Pressed for cash, the government will take the easy way out: It will crank up the printing presses. The final stage of this intergenerational theft will be the debasement of our currency.
    In the context of his quote above, the testable IF/THEN statement is:
    If the FED montizes the Federal debt, then the currency will depreciate (debase).
    I think the appropriate studies to summarize would be studies that examine the link between the monetization of Federal debt and the change in inflation.

  2. Anonymous Jones

    The “intergenerational theft” usage is just amazing.
    Shorter Ryan: “Why allow currency debasement to complete the intergenerational theft? Let me steal it all now so I can give it to the wealthy! Why wait?”

  3. Ricardo

    I get really irritated at the personal attacks that pretend to be economic analysis.
    Stevenson and Wolfers are described by the New York Times as “the go-to pair on what some might call ‘lovenomics.’” The Times continues, “Their daughter, Matilda, who is almost 2 1/2 , attends classes in art, music and soccer. She is not allowed to eat any meat or sugar, not even in birthday cake…
    …they are themselves a couple — unmarried, for tax reasons they regularly cite…”
    There is much more but this is enough to demonstrate that this couple is not exactly mainstream – no sugar in birthday cake! Only Mayor Bloomberg would see this stereotypical couple of nutty Progressive idealists is qualified to call Paul Ryan an “Inflation Nutter.”
    Why are Progressives such hypocrits that they believe being mean-spirited and cruel substitutes for reason and logic?

  4. B'sGambit

    The Fed not only holds long term treasuries, but TIPS as well, distorting the “market” perception of TIPS breakevens (inflation expectations). Because the Fed holds long duration treasuries/mortgages, they could be forced with the choice of combating inflation via higher short term rates and blowing up their own balance sheet (- carry), or letting inflation run. It may not be the modal outcome, but it’s an enormous risk. Unit labor costs aren’t pointing to quite as much slack as you suggest and arguably foreign labor slacks importance grows with globalization.

  5. Tudor

    “I get really irritated at the personal attacks that pretend to be economic analysis….
    …Only Mayor Bloomberg would see this stereotypical couple of nutty Progressive idealists is qualified to call Paul Ryan an “Inflation Nutter.”
    Why are Progressives such hypocrits that they believe being mean-spirited and cruel substitutes for reason and logic?”
    That’s a pretty impressive lack of self-awareness you’ve got there, Ricardo. Stevenson and Wolfers present clear arguments based on market and forecaster data that Paul Ryan’s inflation expectations are rather far from consensus reality. You dispute these arguments by calling them a bunch of names.
    Somehow, I missed the part of your argument that is based on reasonable and logical economic analysis.

  6. Anonymous

    What a f****** [edited for profanity - MDC] political hack you are Menzie…..but then when you don’t teach any courses, just suck off Wisconsin taxpayers, you have time for this sort of political BS. Keep up the good work……Probably good that you teach so little..
    At least Hamilton is concerned with REAL economic issues…

  7. Menzie Chinn

    Ricardo: Well, after your personal attack on Stevenson and Wolfers, do you want to provide some actual data that validates Representative Ryan’s Weltanschauung?

  8. c thomson

    What about some examples of successful inflation forecasting more than 12-18 months out by mainstream academic economists? During the Kennedy/Johnson time, especially?
    And why would we expect our current ‘leadership’ to put on the monetary brakes if inflation started to accelerate while unemployment remained 6-7%?

  9. Mark Thomson

    Can you comment on the difference you see between (i) Ryan’s views outlined in your quote -
    “Unless we change course, we will have a debt crisis. Pressed for cash, the government will take the easy way out: It will crank up the printing presses. The final stage of this intergenerational theft will be the debasement of our currency.”
    and (ii) those of your colleague James Hamilton, who wrote last week in the WSJ (http://on.wsj.com/Z2magX) -
    “Countries with high debt loads are vulnerable to an adverse feedback loop in which doubts by lenders about fiscal sustainability lead to… a fiscal crunch—a point where government bond rates shoot up and a funding crisis ensues.
    A fiscal crunch would force a central bank to pursue inflationary policies, a situation that’s called fiscal dominance. …Indeed, without monetization, the government could end up defaulting on its debt, which would lead to a financial crisis”
    Is the view described by Hamilton significantly different from Ryan’s, or is Hamilton, in your opinion, also an inflation nutter? Have you discussed this with him?

  10. Joseph

    First JDH presents a regression on PIIGS that says inflation is going up.
    Now we have a regression on PLOGs that says inflation is going down.
    I’m guessing that if you regress the PIIGS on the PLOGs, inflation will be flat.
    I love economics.

  11. Menzie Chinn

    Mark Thompson: Let me quote from the conclusion of Greenlaw et al.:

    …Unsustainable fiscal policy could result in a large increase in the inflation risk premium for U.S. government debt, leading to possible substantial losses on the Fed’s balance sheet. This could further feed back into rising longer-term inflation expectations, raising the risk of an unwelcome surge in inflation.

    If long-run fiscal policy were shifting in the right direction, consistent with a gradual decline in the debt burden, accommodative monetary policy would be the appropriate response to a weak economy. Unfortunately, such a shift in U.S. fiscal policy is still far from apparent, complicating significantly the choices for monetary policy makers.

    In Representative Ryan’s document, the word “will” figures prominently (and seemingly, within the next ten years). In the conclusion to Greenlaw et al., such definitive predictions are lacking.

  12. C Jones

    If I could make just one observation though when looking at market based variables – these are not genuine expectations about the future, they are merely todays spot expectations about the future.
    And that’s a key difference just like when 30year Greek yields reached 3.86% in 2005 because ‘today’ there was no problem.
    But I’m not arguing that therefore we should ignore market based metrics, but to say the forward inflation curve currently shows no problems is not to say that therefore there will be no problem in the future.
    All markets are enjoying the policymaker sponosored QE boost – namely, low volatility and low tail event risk – and the inflation market is just another market which, like equities, credit, EM, does not want to ruin the party. Core fixed income yields are so low that returns are being forced though ‘risky assets’ and it’s important for this to play out that the inflation market complies.
    Put another way: when policy makers directly interfere with core fixed income markets – which are the starting point for valuing ‘the future’ and valuing other financial markets – I think we should entertain the idea that it is not just future economic activity we have PV’d with this policy, but the future more generally i.e. todays markets just entirely reflect spot with no accurate measure of the future being possible. Enjoy QE today and worry about it ending only when it ends.

  13. Jeremy

    Menzie,
    As course material for a better understanding of inflation risks, I recommend you read
    “Extraordinary Popular Delusions & the Madness of Crowds” by Charles Mackay.
    I am quite serious. Many extremely smart people have been fooled into thinking printing money is free and has no consequences.
    Also read this brief article by Bill Gross
    http://www.pimco.com/EN/Insights/Pages/Money-for-Nothin-Writing-Checks-for-Free.aspx
    Conservatives are not “nutters” they just think more conservatively. Being conservative, they worry about things like excessive debt and printing money.
    Of course, there is another perfectly valid less conservative way to look at things – don’t worry, be happy and keep spending indiscriminately! After all Greece is beautiful country and so is the USA and so far so good.

  14. Stevey Jones

    @Anonymous Thank you for the most hilarious comment I’ve read on here for a while. Menzie, I don’t know how you put up with these clowns.
    Everyone reading this blog – if CPI-U year over year (monthly data) core inflation exceeds 3.0% at any time in the next 36 months, I will eat my own hat. Or mail @Ricardo a $20 bill.

  15. Menzie Chinn

    C Jones: Thanks for the comment. I must confess that your statement:

    “If I could make just one observation though when looking at market based variables – these are not genuine expectations about the future, they are merely todays spot expectations about the future.”

    is perhaps the most incomprehensible statement I have read in the past year. I thank you because I am going to use it as an example of confused thinking in my class on finance.

    Jeremy: Then I’m a conservative too! I wrote about the perils of running deficits at full employment in 2005! Where were you then? I betcha you thought that was just fine to spend up to a trillion dollars against a backdrop of massive tax cuts. And in any case, debt and monetization make an appearance in my macro course, so I understand they are issues — just not necessarily now.

  16. CoRev

    Menzie said: “…fine to spend up to a trillion dollars against a backdrop of massive tax cuts.”, but the reality is that the 2005 US deficit was: $318,346Bn and in 2006 $248,181Bn, and in 2007 $160,701Bn. Notice the trend, ~50% cut.
    The Dem administration then set a new normal with: 2009 $1, 412,688Bn and in 2010 $1,293,489Bn and in 2012 $1,299,595Bn. This trend is ~8%. Data is from here: http://www.whitehouse.gov/sites/default/files/omb/budget/fy2013/assets/hist01z1.xls
    I dunno, I see a difference in success in the deficit reduction policies of the two administrations in spite of your own feelings about spending up to a trillion dollars against a backdrop of massive tax cuts.

  17. The Rage

    Jeremy, the US is not printing money now.
    Deflationary spiral would default the US on its debt. Already has done that several times. That is why the people got sick of it.

  18. 2slugbaits

    CoRev Ugh. Funny that you “forgot” to show the change in the deficit from 2000 through 2004. And funny that you didn’t mention the deficit in 2008. And funny that you didn’t mention what Bush’s 2009 deficit was (remember, the first four months of FY2009 were under Bush). And funny that you didn’t distinguish between what happened with the on-budget side and what happened with the off-budget side. And funny that you seem to think it’s okay to run an on-budget deficit of 2.5% of GDP at the peak of the business cycle when we should have been running large surpluses. Still haven’t taken that intro to macro course I see.

  19. Jeremy

    Menzie,
    Agreed – our problems go way back. Actually I can’t decide who is worse, Helicopter Ben or Alan Greenspan?
    Alan Greenspan held interest rates too low for absolutely no justifiable reason causing a bubble in housing/markets.
    Helicopter Ben is keeping interest rates too low (ostensibly for justifiable reasons) even though this potentially ruinous policy is demonstrably ineffective in helping the sluggish economy. Helicopter Ben is also causing a bubble in the markets.
    The Chairman of the FED Reserve ought to seek greater stability rather than boom & bust!

  20. JBH

    As a general rule, I dismiss out of hand any article that uses pejorative words referring to the author in its title. That’s first off.

    Survey of professional forecasters, BLUE CHIP, even the 10-year TIPS-Treasury spread can’t be relied on for a 10-year forecast. How much more so at this unique point where never before has so much base money been injected into the system in such a short time. The gold market of course tells a different story.

    Each dollar of base money growth creates about a half-dollar of inflation in normal times. You can look it up. As base money has grown at an annual rate of 30% since Lehman, inflation ought to be running at a 15% rate. It is not doing so because the monetary transmission mechanism is broken. No one knows when it is going to heal, or at what rate that will take place. But inflation is etched in granite if it heals rapidly and the Fed drags its heels on exiting.

    It is the nature of the economic world to throw curve balls, unanticipated and sometimes deadly. This piece takes no cognizance of this elemental fact.

    Furthermore, Ryan is way beyond these authors in that his concern is the deleterious growth of debt. What’s the CBO’s forecasting record on this score? Knowledgeable readers know. The market’s greatest fear is that the US will default on its sovereign debt as there is little political will to deal with it by cutting spending. In fact, the desire on the Democratic side is to pile on more. What gold is proxying is the effects of the monetary base growth, lack of political will to cut deficits, out-year growth of the debt, and possible eventual default-by-inflation to a degree economists have not yet begun to imagine.

    ”Why is everyone so much less worried about inflation than Ryan?” they ask. “Everyone” is not. Those with skin in the game are very worried. And history is on their side. Academic economists who can’t and haven’t forecast their way out of a wet bag aren’t worried. They don’t know enough to be. The Fed is emphatically on record as being dovish at this juncture, with a 100-year demonstrated record of (nearly) always being behind the 8-ball. Yet each month banks are another month more healed; and so then is the monetary transmission mechanism since that’s where it’s broken. Asset price bubbles are already forming. Gold is not a bubble. It is the undisputed truest arbiter of monetary goings on. Do the empirical work and you will see. That work, though, is literally not possible for most academics as economists have been blinded by Keynes’s label of gold as a “barbaric relic.” And the Fed has already slipped the collar from its tight 2% target to a looser 2½% one. Which is just the beginning. And as everything has to start somewhere, wage inflation has tripled since its October low. What is important is not the next year or two, but the full 10-year horizon ahead. In an era of fiat money unlike any the world has ever seen! Where 90% of academia, all liberals, all Democrats, the White House, the BoJ, the ECB, the PBoC, and our central bank are all to a man lopsidedly leaning hard on all the policy levers for more inflation.

    They didn’t listen to Churchill either until it was too late.

  21. CoRev

    2slugs, its too bad you included your self. We’ve had this discussion for too many years. It was Menzie who set the start 2005 date. 2008 was a recession year and different policies were in force.

  22. Menzie Chinn

    JBH: Would that be the same Churchill who put Britain back on the gold standard? I think looking to Churchill for optimal economic policy is problematic.

    Jeremy: I don’t know about looking up the “facts” you mention (what the heck is a “half dollar of inflation”?), but if I regress CPI on money base, 1959M01-2007M12, I get a coefficient of 0.23. If I regress the 12 month percentage changes (in logs), I get a coefficient of 0.25.

    Interestingly, over this sample, price levels are not cointegrated with money base and GDP.

  23. Joseph

    “Would that be the same Churchill who put Britain back on the gold standard?”
    No, I don’t think he is referring to that earlier episode which even Churchill later admitted was his biggest policy blunder. JBH, instead, is going full-on Godwin about Munich, ironically overlooking the fact that it wasn’t inflation but deflation that brought Churchill’s nemesis to power.

  24. 2slugbaits

    CoRev It was Menzie who set the start 2005 date. 2008 was a recession year and different policies were in force.
    No, I think Menzie’s point was that a policy of running structural deficits was in place during both periods. The deficit in 2008 was due to two factors: the structural deficit and the cyclical deficit. The deficit in 2005 was due to a structural deficit. Competent budget policy would have had us running a surplus in 2005.
    I agree that we’ve had this discussion before. And explaining over and over again the difference between structural deficits and cyclical deficits as well as the difference between on-budget deficits (which the President controls) and off-budget surpluses (which the President doesn’t control) is very frustrating.

  25. Johannes

    Hi Menzie, just relax.
    Times are not that bad, the DOW is doing great as Ben keeps on printing. GS has won says Buffett.
    NO, JBH means the Chamberlain words “peace in our time” after Munich and Churchill was the single voice being sceptical about the “everything under control” guys. Anyway, Menzie, stay calm, Ben has everything under control, there is peace in our time. Ah, hm.

  26. Johannes

    Hi Menzie, just gave you a quick history lesson about Churchill in my former post and I would like to ask you for a favour :
    Could you please write a post about the change in the chinese leadership (Xi-Li team), i.e. what do you think about esp. Mr Li Keqiang (PhD in economics), which background does Mr. Li has and which intentions do you think he has ?

  27. JBH

    Menzie: By going all the way back to 1959 you are conflating two completely different time periods. They are different for reasons unnecessary to go into in this short post. However the 20 years prior to August 2008 have the benefit of being reasonably homogeneous and of course being the most recent past. So it suffices to use Aug 1988 to Aug 2008 as the base period. (Or use the prior 10 years if you want.) Now the regression analysis you’d use in this base period gives a nonsensical result; for this time period, the relationship between the two growth series using monthly data is negative. Yet the MB rose on trend as did the CPI. So think about it a different way, as one long distributed lag. Compute the average annual growth rates of the base and inflation during these “normal times”, take the ratio of the two, and you find each percentage point of base growth led to a half point of CPI growth. That was my statement. The rest follows. Ryan I believe gets it. Churchill would too. Churchill was spectacularly right on the important thing – the looming danger of Hitler.

  28. Menzie Chinn

    JBH: Do you have access to Excel? Why do a ratio? A regression of 12 month growth rates makes much more sense, and yields coefficient of 0.066.

    Johannes: Well, like “duh”, I knew that’s what he meant. I was clarifying that in terms of economics, Churchill was not so prescient.

    I can’t say I have any particular expertise in divining what the Chinese leadership intends. Suggest you read Eswar Prasad‘s take.

  29. JBH

    Menzie: I explained all that. From 1998:8 through 2008:8, the regression of CPI on MB (log changes) has R2=.009 and coefficient of -.045. This nonsense coefficient is misleading as both the CPI and MB grew substantially over this time. But the simple ratio of their average growth rates over the period tells the story quite clearly to anyone who wants to hear it. At $85 billion monthly today, the monetary base is growing at a 38% rate which – if the monetary mechanism weren’t broken – would mean inflation on the order of 17%.

  30. CoRev

    Sigh, 2slugs, you didn’t respond to Menzie’s comment to mine which WAS about budget deficits and policy results. Perhaps you think structural and cyclical deficits are devoid of any policy impacts, but I learned that they were actually POLICY DECISIONS.

  31. Menzie Chinn

    JBH: Log differencing removes the trends in I(1) processes. The ratio of growth rates is the same as a bivariate regression w/o a constant allowed. So you are imposing a zero constant for no particular reason. I’m not sure what that tells me.

  32. Ricardo

    Menzie,
    I have taken my lead from you. I do offer economic analysis, but my comments were not economic. My comments were to point out the Progressives do not engage in economic analysis but the politics of personal destruction. They are just naturally haters and mean-spirited; they just can’t help themselves.
    I will save my economic analysis for academics rather than slanderers.

  33. Ricardo

    Apart from disrespectful article by Stevenson and Wolfers let me comment on the Ryan budget.
    The Ryan budget is a joke. Ryan writes: “On the current path, spending will increase by 5% each year. Under our proposal, it will increase by 3.4%.” How many of you received a 3% increase in your income last year? And Ryan pretends that somehow a 3.4% increase is returning government “to its proper limits and focus.”
    It is absure that Democrats are attacking the Ryan budget. It is more like the Democrat budgets, back when they were honoring the law and submitting budgets, than the Democrats submitted. They only reason it looks moderate is because of the disastrous rumblings concerning the Obama budget and the horrible $1 trillion in tax increases contained in the Democrats budget. It is a case of pick your poison, fast acting or slow acting.

  34. 2slugbaits

    CoRev Economics is not brain surgery.
    It also shouldn’t be brain dead, which pretty well describes Dr. Carson’s rambling comments.
    The only substantive comment he made was an appeal for health savings accounts. Well, what’s stopping him or you or anyone from establishing a health savings account? Nothing. Oh wait…he wants the taxpayer to subsidize that account, which somehow he doesn’t seem to equate with government spending. In any event, personal health savings accounts are essentially adventures in self-insurance. Not very efficient. Maybe if the good doctor actually bothered to study economics in his spare time away from his neurosurgeon duties he might figure out why so many conservatives argue for those kinds of individual accounts…hint, it has nothing to do with efficiency and optimal consumption/saving decisions.

  35. Anonymous

    @ the anonymous on march 14.
    I agree with Menzie about 0% of the time, but your insults were pretty pathetic. It’s a testament to Menzie’s fairness (after all libs love equality) that he allowed that post to exist.

  36. Anonymous

    @ The Rage
    There is no such thing as a deflationary spiral. This is something that was made up by the elite to rationalize spending. The lower prices fall, the more likely people are to spend.

  37. Joseph

    anon: “There is no such thing as a deflationary spiral. This is something that was made up by the elite to rationalize spending. The lower prices fall, the more likely people are to spend.”
    So you are saying you would buy a car for $20,000 this year knowing that you could buy it for $15,000 next year?
    This is why I think the “rational” expectations theorists are all wet. As Summers said “There are idiots. Look around.”

  38. Ricardo

    Here is the Heritage Foundation analysis of the Democrats first budget in 5 years. Perhaps Menzie can tell us why it is so much better than the Republican budget. Hmmmmmm!

  39. cliff

    So you are saying you would buy a car for $20,000 this year knowing that you could buy it for $15,000 next year?
    This is why I think the “rational” expectations theorists are all wet. As Summers said “There are idiots. Look around.”
    So you are saying you would buy a computer for $2,000 this year knowing that you could buy it for $1,500 next year?
    Yea, how stupid could you be?

  40. Anonymous

    @Joseph -
    “@So you are saying you would buy a car for $20,000 this year knowing that you could buy it for $15,000 next year?”
    #1 you don’t “know” that.
    #2 At the end, if a deflationary spiral really existed, eventually I could buy every good and service in the world for a penny.
    #3 Has a deflationary spiral ever occurred? No. Price adjustments have, but prices never spiral to zero.

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