Delong and Krugman on Cochrane

By Charlie Clarke

Brad Delong and Paul Krugman are not happy with John Cochrane.  Brad Delong says John Cochrane is wrong, and Paul Krugman says he thought of it first.

Here is the original from 2009 (except everything in bold was cut):

If we just had a credit crunch, we would expect to see stagflation – lower quantities sold, but upward pressure on prices. A credit crunch, like a broken refinery is a “supply shock.” Since we are seeing lower quantities sold and easing inflation, we must also be seeing a “demand shock,” and we need to understand its source.

The bottom line, then, is that people want to hold more of both money and government debt – and don’t particularly care which.  Trying to get it, we are trying to buy less of both consumption and investment goods. Again, this is a deflationary pressure. If the government does nothing, deflationary pressure will remain until goods are so cheap that we have the desired real value of nominal government debt.  Until deflation happens, output falls.

What do to? In this analysis, monetary policy is impotent, but not for the usual reason that interest rates are nearly zero. The Fed can arbitrarily exchange Treasury debt for money, and increase the money supply as much as we like. But nobody cares if it does so, since the “flight to liquidity” is equally towards all forms of Government debt.  If we want more fruit and less cheese, putting more apples and less oranges in the fruit basket won’t help.

Looking at it this way gives us a logical reason that fiscal stimulus might work. It leaves the private sector with a trillion more dollars of government debt in their pockets. But the Fed’s many facilities also issue government debt and money, which helps to satisfy the demand for government debt.  Which is the better path?

I think the bolded sections make clear that Paul Krugman has the right response.  Cochrane is in all senses agreeing with Brad and Paul's analysis.

Cochrane goes on to disagree with fiscal policy for much more banal reasons.  He worries the money would not be spent well.  He prefers "fiscal policy" by which he means that the Fed could buy up lots of almost safe debt, "I would be happiest if the Fed and Treasury satisfied the large demand for government debt and money by transparently buying or lending against high quality corporate and securitized debt, at market prices."