Professor John Cochrane Says Chairman Paul Volcker Had It Backwards

A Benjamin Cole post

I admire Professor John Cochrane of the University of Chicago, an economist who has an open mind, a rarity when macroeconomics is usually politics in drag, and right-wingers are cowed into conventional and conservative dress by their brethren.

But they have not cowed Cochrane.

So we have Cochrane calling for converting of the entire national debt into commercial bank reserves (through quantitative easing, no less!), and for all bank lending in the U.S. to be 100% equity-backed. By law, regulation and federal diktat, no less.

Okay, while we mull that, Cochrane then reiterates the right-wing fetish for the zero-inflation or even deflation imperative, but then he comes out a with a flaming wild lulu on how to get to the dead-prices promised land: lower interest rates!

The Fed should impose lower and lower interest rates to fight inflation, asserts Cochrane.


Well, maybe we can comprehend what Cochrane is saying, and maybe not. Cochrane’s unusual perspective on interest rates is matched by his take on QE, which he has also posited is anti-inflationary.

On rates, Cochrane cites a recent study by Stephanie Schmitt-Grohé and Martín Uribe, entitled The Making Of A Great Contraction With A Liquidity Trap and A Jobless Recovery. Then Cochrane blogs, “raising the nominal interest rate to its intended target for an extended period of time, rather than exacerbating the recession as conventional wisdom would have it, can boost inflationary expectations and thereby foster employment.”

The pair of authors add that the Taylor Rule is uninformed, as it calls for dropping rates in deflationary recessions. Indeed, Taylor knows nothing: A Fed rate hike to, say, 6% is the right elixir now for the U.S., proffers Cochrane. Toilet-time for the Taylor Rule.

The rate hike would be effective Fed signaling despite the head fake, avers Cochrane. See, the Fed is saying it expects higher inflation and growth, when it raises rates. “By pegging the interest rate at a higher level and just leaving it there, the Fed communicates that expected inflation had better rise in the Fisher equation,” explains Cochrane.

Chairman Paul Volcker Had It Wrong?

Of course, Cochrane’s bold new stance pulls the rug out from under one of greatest, most glorious and hoariest of inflation-fighting stories of all time, that of Fed Chairman Paul Volcker smiting inflation in the early 1980s.

In 1981, inflation was 13.5%, but Volcker tightened the screws like never before, and inflation tanked to 3.5% by 1983. The prime rate topped 20% for a while, when Volcker was Volcker. In those glory days, I can remember 15% home mortgages. Unemployment hit double-digits too. Truth is, it was ugly.

But We Suffered For Nothing

Based on enlightenment via Cochrane, I surmise now Volcker had it all wrong, and we suffered back in the early 1980s for nothing.

Had Volcker lowered rates, that would have signaled to the market that inflation was in retreat, and we could have sauntered into lower inflation and higher employment without the pain of recession. Like Fed jujitsu!

If only we had known.

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