Could a Central Bank Fail To Inflate?

John Cochrane has become well-known in recent years for his conservative political views, but the opinion he expresses in today’s NYT forum about inflation is strangely widespread across ideological lines. He says that not only would it be unwise for the Federal Reserve to try to create inflation, it would be impossible as well:

The fact is, the Fed is basically powerless to create more inflation right now—or to do anything about growth. Interest rates can’t go below zero, and buying one kind of bond while selling another has minuscule effects.

I’ve heard this from economists like Jamie Galbraith on the left and Lawrence Summers in the middle as well, and I don’t buy it at all. The problem is that there’s a huge logical gap between the sentences. It is true that those particular things don’t create much inflation. But what if the Fed did other things? For example, consider the “minuscule effects” of quantitative easing. Those aren’t zero effects. In fact, inflation expectations have risen when the Fed has announced rounds of easing.

Have they risen a lot? No. Presumably because the Fed doesn’t want them to rise a lot. But suppose the Fed announced a big new round of Quantitative Easing and said “the purpose of this bond buying is to raise inflation expectations above 3 percent”? Suppose they said “the purpose of this bond buying is to raise inflation expectations above 3 percent and we’ll keep on buying bonds until it happens?

I think that small tweak in strategy gets you from “minuscule effects” to bigger effects. The issue is that the Fed gets what it wants. If it wants to raise inflation expectations a little, it gets a small effect. If it wants a bigger effect it needs to communicate that fact, and it’ll get the effect.

The other way to look at it is not in terms of a policy recommendation, but it terms of what might be possible if the Cochrane viewpoint were correct. The Fed could, on that view, simply buy all the outstanding debt in the country and then tear it all up. Wouldn’t that be a bonanza? Yes it would be “unfair” since the highly indebted would benefit more than the prudent. But virtually everyone has at least some debt or owns shares in companies that have debt, and absolutely everyone is implicitly responsible for different forms of public sector debt. And we’re not talking about a Universal Jubilee at the expense of creditors here. Every creditor would be paid in full by the Federal Reserve, and every debtor would receive complete relief from debts. Wouldn’t that be lovely? But of course it’s a fantasy. If you did that there would be tons be inflation.

So I’m not saying we should do that. What I’m saying instead is that Cochrane is wrong. But what I’m saying more broadly is that if you do think the Fed can’t create inflation, that’s a view with some wild implications for the world beyond boring monetary policy conversations.