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Robert Hetzel and the risks of inflation

Summary:
Here’s the abstract of Robert Hetzel’s new Mercatus paper, which discusses the Fed’s response to Covid-19: The quantity theory, which posits a causal relationship between money and prices, is among the oldest theories in economics. Starting in March 2020 as the COVID-19 pandemic affected the United States, money surged at a historically rapid pace. Historical experience, most recently with the Great Inflation of the mid-1960s through the 1970s, suggests that an uncontrolled surge in inflation is coming. Other factors in the intellectual and political environment are also reminiscent of the Great Inflation. The Federal Reserve has reverted to its 1950s “cost and availability” view of monetary transmission. There also exists a widespread belief that inflation is a

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Here’s the abstract of Robert Hetzel’s new Mercatus paper, which discusses the Fed’s response to Covid-19:

The quantity theory, which posits a causal relationship between money and prices, is among the oldest theories in economics. Starting in March 2020 as the COVID-19 pandemic affected the United States, money surged at a historically rapid pace. Historical experience, most recently with the Great Inflation of the mid-1960s through the 1970s, suggests that an uncontrolled surge in inflation is coming. Other factors in the intellectual and political environment are also reminiscent of the Great Inflation. The Federal Reserve has reverted to its 1950s “cost and availability” view of monetary transmission. There also exists a widespread belief that inflation is a nonmonetary phenomenon. In Keynesian terms, because the Phillips curve, which relates inflation and unemployment, is presumed to be flat, the Fed can push the unemployment rate to historically low levels. Federal Open Market Committee (FOMC) chair Jerome Powell asserts that the course of the recovery will be dictated by the behavior of the virus. That makes sense in that the recession arose as a shock to potential output. Powell and the FOMC, however, treat the recession as if it originated in a large negative aggregate-demand shock requiring extremely stimulative monetary policy. The FOMC should follow a rule that ensures that the spring 2020 bulge in money dissipates.

The paper presents a monetarist critique of recent Fed policy.

I’m less worried about inflation, as you don’t see high inflation expectations in the TIPS markets. But Bob is right that the intellectual climate increasingly resembles the 1960s, when belief in a (flawed) Keynesian model led to some serious policy errors. So this is certainly something to keep an eye on.


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Scott Sumner
Scott B. Sumner is Research Fellow at the Independent Institute, the Director of the Program on Monetary Policy at the Mercatus Center at George Mason University and an economist who teaches at Bentley University in Waltham, Massachusetts. His economics blog, The Money Illusion, popularized the idea of nominal GDP targeting, which says that the Fed should target nominal GDP—i.e., real GDP growth plus the rate of inflation—to better "induce the correct level of business investment".

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