JohnH.Cochrane-BoothSchoolofBusiness.pdfVIP

Inflation and Debt John H. Cochrane or several years, a heated debate has raged among economists Fand policymakers about whether we face a serious risk of inflation. That debate has focused largely on the Federal Reserve?—?especially on whether the Fed has been too aggressive in increasing the money supply, whether it has kept interest rates too low, and whether it can be relied on to reverse course if signs of inflation emerge. But these questions miss a grave danger. As a result of the federal government’s enormous debt and deficits, substantial inflation could break out in America in the next few years. If people become convinced that our government will end up printing money to cover intractable deficits, they will see inflation in the future and so will try to get rid of dollars today?—?driving up the prices of goods, services, and eventually wages across the entire economy. This would amount to a “run” on the dollar. As with a bank run, we would not be able to tell ahead of time when such an event would occur. But our economy will be primed for it as long as our fiscal trajectory is unsustainable. Needless to say, such a run would unleash financial chaos and re- newed recession. It would yield stagflation, not the inflation-fueled boomlet that some economists hope for. And there would be essentially nothing the Federal Reserve could do to stop it. This concern, detailed below, is hardly conventional wisdom. Many economists and commentators do not think it makes sense to worry about inflation right now. After all, inflation declined during the fi- nancial crisis and subsequent recession, and remains low by post-war standards. The yields on long-term Treasury bonds, which should rise John H. Cochr a ne is the AQR Capital Management Distinguished Service Professor of Finance at the University of Chicago Booth School of Business, a research associate of the National