Juliette Sellgren 

Science is the great antidote to the poison of enthusiasm and superstition. Hi, I'm Juliet Sellgren, and this is my podcast, the Great Antidote- named for Adam Smith, brought to you by Liberty Fund. To learn more, visit www.AdamSmithWorks.org. Welcome back. Today on December 20th, 2024. I'm excited to welcome Professor Eric Leeper to the podcast. He's the Paul Goodlow McIntyre professor in economics at the University of Virginia. He's also a visiting scholar at the Mercatus Center at GMU. He likes to do woodworking, which he's very good at. In his spare time, he says that he's not a good guitarist, although I don't entirely believe him. Today we're going to be having a conversation about the relationship between the fiscal and monetary sides of the economy, how inflation happens, what happened under [Paul] Volcker, what happened during Covid, and try to keep that in time. So welcome to the podcast.

Eric Leeper 

Thank you.

Juliette Sellgren (1:11)

First, what is the most important thing that people my age or in my generation should know that we don't?

Eric Leeper (1:19)

History? And this struck me profoundly. When the Covid inflation hit and it got to , to 8% and people had a hissy fit, they had no idea what inflation was or what caused it or how long it's going to last, or what the implications were. As somebody who lived through what's called the great inflation in the seventies and eighties, I thought, holy moly, read a book. And I kind of wish a lot of policymakers would read that book also, because I think we understand inflation better than it seems. We understand it based on what you read in newspapers and what you hear from policymakers. And I think that this is a good example where history has a lot to teach us. 

Juliette Sellgren 

I think you're right. You said a book, but which book?

Eric Leeper (2:37)

Virtually any book about inflation, the history of inflation. Tom Sargent has a very accessible set of essays in a book called Rational Expectations and Inflation. I think that's a great place to start. He talks about hyperinflation, he talks about the Volcker era, he talks about Maggie Thatcher. Now of course, these are by today's standards, historical events. When he wrote it, they were contemporaneous, but I think that's a great place to start.

Juliette Sellgren (3:19)

So I guess as we get into this, can you outline for us, even though you did just mention that we were all a little bit of idiots for not knowing this during Covid, what is inflation?

Eric Leeper (3:36)

Well, inflation is, I want to think about it as a sustained increase in the rate at which overall prices in the economy change. So you can think about something like the consumer price index, which is telling you how much a certain basket of goods and services costs at a point in time. And so inflation is the rate of change of that dollar price of that basket of goods and services. And critically, I want to think about this as a sustained change in that rate of growth because it's hopeless for us to try to ever explain blips in inflation rates, just as I think it's hopeless to try to explain why the stock market went up one day and down the next. It doesn't prevent people from doing it, but I don't think we learn much from that. But I think we have a lot to say about what underlies sustained changes in the rate of growth of the overall price level.

Juliette Sellgren (5:01)

So part of why we're having this conversation is because A, you're an expert on this subject, and B, you're writing a book about it. So obviously you can recommend to us Tom Sergeant's books and all these other books that can really help us. But what compels you to write a book on this subject and to contribute to the way that we understand and talk about this phenomenon?

Eric Leeper (5:29)

Well, I'll refer to Tom's book again because one of the themes of that book is that inflation is always about monetary and fiscal policy together. And any effort to try to understand it by looking only at one policy, either what the Fed does or what Congress does is doomed to failure. That's been the theme of a lot of my research ever since graduate school. And for decades, I was dismissed by economists who while they would agree that the logic that you need to understand monetary and fiscal policy together is compelling, they argued that well, but in practice, that doesn't seem to be any big deal. And these are people who were beating themselves on the chest because after Volcker managed to get inflation down, it really stayed down in the United States until Covid came along. And so they had declared victory in the effort to understand how to keep inflation low and stable by thinking only about monetary policy.

(6:54)

So I have tried through various venues over the years to communicate to a non-technical audience how it is that monetary and fiscal policy jointly interact to drive what happens to inflation. And to be perfectly honest, I think I've largely failed in that task. Despite having given countless talks and written many papers that have been published, say in Central Bank publications around the world or conversations with policymakers around the world, I have had essentially no influence on how they think about inflation. So in the last year, through my connection with the Mercatus Center, I have spent some time on Capitol Hill where the most rewarding interactions have been with staff of various committees on Capitol Hill. And what I see in those staff members is these are smart people who are not trained economists. They're not technically oriented, but they really want to try to understand what inflation is, what causes it, how to cure it. And they come to that question with open minds. They don't come to it having been weaned on monetarism.

(8:42)

Their mother's milk wasn't tainted by a particular ideology about what drives inflation, unlike many professional economists. And so what I have seen is that even in my interactions with them, I haven't completely succeeded in communicating. So I thought, now is the time to write a book that is really geared toward people like those staff members I would include in the list of potential readers, financial journalists. I have had tremendous frustration in trying to talk to financial journalists about inflation because they have a narrative and they're going to stick to it, and they will acknowledge that I have a different viewpoint, but ultimately they know what the truth is, and here it is. So my hope is that I might get some of them to read this book. It's written at a level that undergraduates could read it. So I hope that maybe it'll reach some academics as well.

(10:07)

But that's really what it's about. This comes on the heels of two other books that have gotten some attention. One is a very technical book by John Cochrane about the Fiscal Theory of the Price Level. And that's accessible really only to either extraordinary undergraduates or graduate students in economics. And then there's another book by Alan Blinder entitled A Monetary and Fiscal History of the United States, which everything that Blinder writes is beautifully written easily to understand, but it's really much more about the history than it is about the economics. And so the economics in that is very kind of intermediate level ISLM. And so it doesn't bring in, for example, the fact that there's a government budget constraint that is the reason that monetary and fiscal policy always interact. And so I see what I'm doing is somehow falling between those two books. I'm trying to have the analytical rigor that is in Cochrane, but the accessibility that's in blinder,

Juliette Sellgren (11:34)

I would say that you've not failed in your mission by any means. I mean, I'm sitting here asking questions about it, and I know a lot of people who are sitting here asking questions about it and even just doing more than that because of your work. So I would not go so far as to say that, but also I'm not you and you're also not done. You're still doing it. So can't be a failure if it's not over, at least I think unless you're trying to make a scrambled eggs and you've dropped all the eggs on the floor before you even, but the pan on the stove. But that's clearly not what's happening. I remember growing up and being the only person I knew my age and honestly older, who knew even vaguely what inflation was, and that debt was bad. And you could say maybe that I was told that from a very young age and indoctrinated and whatever, but I was raised in a household where we were economically literate.

(12:38)

And I think that inflation, especially among economic concepts, it's something you don't brush up against unless it's happening to you. And it's like a really bad flu. You don't know how bad it can be unless you're in it. And I think that, I mean, feel like the fiscal monetary people kind of joke about it, but it's true. Before Covid, there was no reason for anyone my age much less younger or even older than I am to have had any experience with inflation, which to your point is why history is so important. But most people I feel like do not read that many books. But part of it is also because academia is difficult and you seem to be bridging that gap. So I don't know, it seems like we're on route to a success here if we're not already looking quite successful. But I don't know how compelling that is.

Eric Leeper (13:36)

Well, it's nice of you to say that. I think I want to make one point about the fact the fact that people were oblivious to, or I should say ignorant of inflation, is a testament to the success of policy in the United States for several decades. And Alan Greenspan, who was the chair of the Fed before [Ben] Bernanke and after Volcker, when he was asked, what is your objective? Or how do you define price stability? What he would say is, well, it's when inflation is something nobody thinks about, it's not a factor in anybody's decisions. And that's basically what you were saying. It didn't play any role in anybody's life, and so there was no reason to know about it.

(14:40)

I think though that what we're experienced with Covid, what we experienced with Covid, and that we are still experiencing, let's not forget that inflation is not back to target, and it doesn't seem to be moving much lower than it is now above 3%. I think that's just the beginning of the issues that we're going to be facing with inflation. And so I'm hopeful that the timing of my book is good, that people will feel that our understanding of inflation is somehow inadequate because golly, we made this fiscal, I think Covid was generated by fiscal policy, and then we turned to the Fed and said, okay, now you mop it up. And what we're seeing is that, well, the Fed doesn't seem to be able to completely mop up that mess, and I don't think the mess is over by any stretch.

Juliette Sellgren (15:51)

So I want to get into the historical aspect, and I want to get more into what happened under Volcker and then what happened during Covid and all of that. But I want to start before we get into those, I guess examples is the way to call them. I want to start with the more theoretical side of just what definitionally is, the relationship between the fiscal and the monetary side. You keep saying this, and the Fed is monetary and fiscal is government spending, but for people who have been raised in this era of sure, it's been working for the most part until Covid, and we didn't have to think about it, great. We still kind of implicitly thought it was fully a monetary situation, but that's not true. So then what is the relationship?

Eric Leeper (16:47)

Well, a lot of economics, it comes down to a budget constraint. In this case, it's the fact that the government faces a budget constraint.

Juliette Sellgren 

But they don’t. I've never thought of that in my life. What do you mean they spend so much money and they can just give everybody checks all the time, right?

Eric Leeper (17:07)

Yeah. And then they borrow to finance those because they have to satisfy a budget constraint. So I mean, it's really nothing different than accounting that inflows have to equal outgoing. And so if taxes don't cover all of spending, then the government has to borrow. But there still is a constraint that has to hold and individuals, the But government can't borrow without limit. And that means that at some stage, policies have to change. And so when you look at, say, the Congressional Budget Office projections into the next 30 years, they have government debt growing exponentially. So that's debt as a share of GDP. That means that government debt is growing not just faster than GDP, but exponentially faster than GDP, and that debt ultimately has to be paid off or defaulted on or otherwise, some adjustments have to be made because there is a government budget constraint that holds now it holds tomorrow and it holds forever. And so that's where, because that government budget constraint involves government spending, taxes, interest payments on the debt, the amount of government debt that's outstanding, and the price level, well, that's where monetary and fiscal policy meet. They meet at that government budget constraint. And because the budget constraint has to be satisfied, monetary and fiscal policy have to be coordinated at least eventually. And so that's why it's inevitable that they interact.

Juliette Sellgren (19:20)

So what does that mean? Just to kind of put it into detail, I guess, a little bit, and to make it a reality, obviously we all just lived through covid not so long ago, but when I go to the grocery store, say people see that prices increase, and we kind of know like, oh, there's this illusion that maybe prices are just increasing a little bit for certain goods, and maybe it's just that, but actually it's the entire price level and those two things are different, but really maybe we're not even thinking about that and we're just thinking about how things are expensive nowadays. How does that affect, I guess, the individual's budget constraint, the individual action that we can take? And is it different when we look at the relationship between inflation having both of these sides versus what I think of as the traditional narrative? But from your research, I kind of know is not the traditional approach, which is just thinking about the monetary side. Does it change the effect on the individual at all or does it just help us to fix the inflation that is happening and obviously causing consequences that we don't like?

That was a lot.

Eric Leeper (20:42)

There are a lot of questions in that.

Juliette Sellgren 

Oh, I know.

Eric Leeper (20:46)

So let me start with the individual because I think this is a really important point. When I defined inflation, I defined it as an increase in the overall price of goods and services, and I said it's a sustained increase. What happened during covid was a lot of stuff, we'll get to what I thought, what I think of as the cause of the inflation in a minute, but there's no question that we had very large swings in the prices of some goods and services relative to others. We had an oil price shock. So the cost of energy went up by more than the cost of other things. That's a relative price increase. We had problems with supply chain, and so the prices of certain kinds of goods went up dramatically the cost because of the supply chain problems, auto manufacturers weren't able to produce at the same level that they wanted to, that they would've wanted to.

(22:07)

And as a consequence, we saw the price of used cars go up by 50% or something. Now, relative price changes are happening all the time in the economy. You can have zero inflation, but you're still going to have the prices of some goods go up relative to others. The critical point there is that if you hold the total demand fixed, so maybe it's best to think about this from an individual's perspective. So an individual has a monthly paycheck of $5,000 out of that, there are certain things they have to pay for. So let's suppose that you see that the price of heating oil has gone up relative to other things. Well, this person is going to want to keep the house warm, and that's going to mean that they're not going to be able to buy some other things that they would otherwise want to buy. So maybe they cut back on their caviar consumption that month.

(23:16)

That is just a relative price change. And because the person's income is fixed, there's nothing they can do to get around that relative price change. Now, let's suppose that what's happening on top of that is that the person's income is growing over time. Well, then there will be these relative price changes, but at the same time, their demand for everything is going to be growing over time. That is really the difference between inflation, which is when demand is growing faster than the supply of goods is, you're seeing that the prices of all goods are going up. But that can happen at the same time that the price of heating oil has gone up by more than everything else has. That's what makes it very difficult to filter out the noise from the underlying inflation. And in fact, you saw that when the Fed talked about inflation initially, they talked about it as transitory.

(24:32)

They thought of it as almost entirely due to these relative price changes, which they figured correctly. We'll eventually just kind of work their way through the system, but not elevate inflation in a persistent way. So the only way that you can get the kind of overall increases in prices that we saw during C is if something is happening on the demand side, it can't just be, and by demand, I mean the overall demand for goods, not simply that, well, we all move from buying services to buying goods because we were all living in our homes. That's relative. That generates a relative price change. So the overall inflation had to be due to some big demand phenomenon. And I think it's pretty clear to those of us who think about monetary and fiscal policy, that what the government did between March of 2020 and 21 was they allocated 5 trillion dollars in new spending.

(25:50)

That was about 20% of GDP at the time. Now, how did they pay for this new spending? Well, they borrowed, and more than that, a lot of this spending was in the form of checks that went out to the public. And when Trump was president, he put his name on those checks. What was being communicated to people was the checks that they received weren't simply there to tide them over like a loan would be. They were gifts. So the difference between a gift and a loan is critical for understanding the source of this inflation. If everyone understood that this was just a temporary loan that we would have to pay back then, yeah, maybe what we would do if we've been thrown out of work is we would use the check to meet our daily expenses, but then we would have to then reduce our savings to some extent because we're anticipating that we're going to have to pay these taxes back in the future.

(27:09)

But once we're told these are gifts, well then we're in a whole different world. Then the checks became a supplement to their lifetime income, or in other words, it became part of wealth. And so what people did was they said, huh, I'm wealthier now. Well, if I'm wealthier, I want to shift my consumption up, not just now, but also in the future. That is an aggregate demand increase. So the overall demand for goods and services went up because of these transfers that were communicated to be gifts. So well, when that happens, you're going to get inflation. So just again, to put this in perspective, during the financial crisis, the fiscal stimulus package that was put together, which was the biggest one in history, was 5% of GDP during covid. It was four times that. So this was a whopping big fiscal stimulus, and it was financed entirely by borrowing.

(28:33)

So that was the genesis of the inflation, and that inflation was going on at the same time that there were lots of relative price changes. Now, that's not the narrative you read about in the New York Times. In the New York Times. It was all about, well, we've got these supply chain problems. There's Ukraine War. They're endless stories about what was causing the inflation. Let's not forget that the meat packers were another source of the inflation. I mean, the list goes on and on, but you're not going to read about in the New York Times or the Wall Street Journal was that there was this massive fiscal stimulus that was basically dumping 20% of GDP in liquid assets onto the private sector, and the private sector then used them.

Juliette Sellgren (29:37)

So what's shocking about the way that you tell it is that, I mean, it is what you just said, that no one would think based on what is told in the newspapers and the story that's told by economists, and even the way that politicians and economists were talking about it at the time, that this is a feasible narrative. And yet this narrative seems to make so much more sense because again, I don't know, maybe I'm just not very educated on the subject, but what the heck does transitory mean? It feels like it. They just made it up and maybe they didn't. It was a term that had been used before. But to me, as someone who doesn't maybe know that much, it kind of feels like it was made up. So I don't know. I guess a brief interlude question, was this a term that existed before?

Eric Leeper (30:34)

Yeah, I mean, that's a perfectly reasonable thing to say if you believe that the inflation was generated, remember that when we talk about inflation, what we have is these price indexes and when they go up, we call it inflation. Now, there are imperfections in how those things are computed, and when there are big relative price changes, it's not at all surprising that those indexes suggests that overall prices have gone up because the kinds of substitutions that I was talking about that, okay, I'm going to move out of, I have to pay more for heating oil, so I'm going to buy less caviar. That stuff doesn't necessarily feed immediately into measured prices. And so it's a perfectly reasonable explanation if there's this one-time shock that hits the economy and you figure, okay, it's just going to kind of work its way out and inflation won't rise persistently.

(31:50)

But I think there's a deeper problem with the way the Fed was thinking about this and that is that they don't distinguish between government spending, which is through borrowing. They don't distinguish between when that borrowing is going to be backed by future taxes and when it's not. So that is the essence of my story, that my story is people didn't believe that taxes were going to rise in the future to soak up all this money that was handed out to people during covid, and therefore they started to spend that money. So lemme just give you a contrast, which I think is really telling. I think it was something like five days after the passage in 2009 of the stimulus package under Obama, he made a pledge that he was going to reduce the deficit by one half by the end of his first term. That's communicating something completely different.

(33:18)

He was saying, yeah, we're going to spend this money now, but we're going to soak it back up. We're going to maintain what I've called the Hamilton norm. It goes back to Alexander Hamilton that deficits need to be followed by surpluses. That's how you ensure the safety and soundness of government debt. We're not going to inflate it away. And so Obama made that very clear. And so he was sort of anchoring expectations at the time on the idea that we're going to go through some sort of fiscal consolidation to get deficits under control. There still to this day has been no discussion of that. There was none during the Trump administration. There's been none during the Biden administration. And the latest noise coming from the incoming Trump administration is, let's say, confusing using, it's not clear that they're talking in any serious way about trying to move from deficits to surpluses. So that is really the key point, is that if you have a model which the Fed does, has plenty of them, that you build in the assumption that every dollar of government borrowing today is going to be backed in present value by a dollar of taxes in the future, well then you're never going to get a covid inflation. You'll get relative price changes moving the inflation rate around, and you'll infer that those are going to be transitory.

Juliette Sellgren (35:15)

And what's shocking about this story, and you outlined this very well in the chapter that you've shared with me of what you've written, is that this has not always been something of shock. This has been a relationship that's been understood for a while, and yet we seem to have forgotten it in the same way that I don't know, I have this feeling, at least when I think about maybe post 2008 to Covid, that we kind of, I mean, it was the Fukuyama end of history thing. We solved inflation and we knew how to do it. It was with the Fed, and we knew how to fix geopolitical conflict. Everything was going to be great, and then we would never be in such a situation. And yet here we are.

(35:01)

But you wrote about how [Paul] Volcker actually understood this relationship and how that's a really important reason why the inflation of the late seventies, early eighties actually got resolved and why we weren't still dealing with all of the problems that came with inflation at the time. I don't know for a fact. I guess we could never know the counterfactual of what we would be dealing with today if he hadn't understood that. But luckily for us, he did. So can you kind of talk to us about, I don't know, what did he do? How did he understand this? How did it get lost? I mean, there are a few economists, right, you and Tom Sargent, John Cochrane, a few who study this and talk about this, but it's relatively uncommon, especially given that someone who is so influential in doing something really important for our economy way back when that this has just kind of been brushed under the rug.

Eric Leeper (37:07)

Okay, so here's a little history of thought. Before [John Maynard] Keynes wrote the General Theory he wrote, attract on monetary reform, which I think can be read to say a lot of the same things that I just said. So he surely recognized that both monetary and fiscal policy mattered for inflation. And if you look then say at this 1948 paper by Milton Friedman, it was all about monetary and fiscal policy. James Tobin wrote all about monetary and fiscal policy. In fact, I think of the fiscal theory of the price level as basically a kind of modern version of things that Tobin wrote. Now, what happened was Friedman had an epiphany, I think, and by 1953 and 1956, he was talking only about money.

(38:33)

And his famous inflation is always in everywhere, a monetary phenomenon. Well, I'm willing to go with that if you're willing to define government debt as part of money. I think that is the case. But he didn't define it that way. So then what happened in the seventies and into the eighties was Monetarism really took over as the single way to think about inflation. But you see what Volcker grew up at a time that predated that he got his economic training at a time when people had the view that, yeah, you got monetary and fiscal policy. We need to be talking about both of those.

And so I don't think he was, sometimes people call him a monetarist because he wanted to get money growth under control, but that's far too narrow a definition of monetarism. I think he was an eclectic economist who understood that fiscal policy has effects on inflation just like monetary policy does. And I'm not for a minute claiming that he had in mind the formal theoretical models that we now use, but his gut told him that if fiscal policy is run amuck, then monetary policy can't control inflation. And he said things like that, that monetary policy alone cannot control inflation. Now let's fast forward to the nineties and the rise of inflation targeting. I think there is an original sin here that inflation targeting kind of formalized a lot of the very narrow monetarist thinking that you could take from some of the more modern things that Friedman wrote.

(40:56)

And suddenly it became this mantra that, well, monetary policy, if financing a numerical inflation target can provide what's called a nominal anchor. It can nail down people's long run expectations of inflation. And then people wrote down models, formal models that showed that what got swept under the rug in all of those models was what was really going on with fiscal policy. And that was kind of what my first paper in 1991, which predates inflation targeting of course, but that made that clear that in order for monetary policy say to target inflation fiscal policy has to provide the right kind of support so that if monetary policy wants to reduce inflation and raises the interest rate when it does that, well, that's going to trigger growth in interest payments on the debt. If fiscal policy doesn't then contract raise taxes, cut spending to finance those interest payments, then monetary policy can't control inflation.

So that little bit got swept completely under the rug by the inflation targeting literature, and it got sold to politicians as a silver bullet that, Hey, we just need to have independent central banks. We need to give them a specific mandate about what to do with controlling inflation and we're done. And then we had the inflation experiences of the nineties and two thousands, which were favorable, and people attributed that to inflation targeting. Well, now we've seen these central banks are still inflation targeters, but around the world we've seen inflation go up. And I can only hope that that gets people to stop and think about whether that whole framework maybe was missing something.

Juliette Sellgren (43:29)

Yeah, I mean, it seems like it was missing a little more than something obviously formalization was needed, but it seems like there are almost, it's ignorant of, well, now I'm going to be cheeky and say it was missing half of the equation because fiscal monetary, half of that is fiscal. But what's odd is it seems so intuitive to someone like me who is kind of learning about this alongside actually learning about, I guess what the monetarists taught the whole while after that. And so I guess how do you teach people who have been trained or even just raised in an era where we believe that the Fed can just handle it to teach them that that's just not true. Obviously you've been trying, but is that the most important lesson? If you were to give us one or two takeaways, what is the most important thing for us to know on this topic? And to just remember when we think about it?

Eric Leeper (44:48)

I think the most important thing is that when you assign tasks to the central bank and to the fiscal authority Congress, you need to make damn sure that the tasks are compatible, that they're consistent with each other. So if you're going to tell the Central Bank your job is to control inflation, then you need to adopt a fiscal framework that will enable that to happen. And that requires a rules on fiscal behavior that go well beyond the kinds of offsets and so forth that Congress talks about. Now, I think probably the reason everyone jumped on inflation targeting is because people understand that fiscal policy is inherently political, and they kind of throw their hands up and say, well, golly, we can't control that. That would interfere with democracy. I think that's wrong for the following reason, that just as with the Central Bank, you say, okay, we're thinking about the welfare of society as a whole when we tell the Central Bank that they should keep inflation low and stable.

(46:21)

Well, you can make exactly that argument that well, we're thinking about the welfare of society as a whole when we say that government debt shouldn't go above some fraction of GDP or something, the distributional aspects of fiscal policy, who's going to pay the taxes? Who's going to get the benefits from spending? While those are inherently political and a democracy, they have to be determined by the democratic process. But to make that argument on the macro level that the macro aspects of fiscal policy also ought to be politically driven, I think is a non-sequitur. I don't think that telling the fiscal authority that you have certain macro responsibilities, no matter who happens to be in the majority, does any violence at all to democracy. And in fact, failing to tell them to do that does damage to democracy, because if you've got high and volatile inflation, it's hard to maintain a smoothly running democratic society.

Juliette Sellgren (47:43)

Yeah. I guess to go back to the example of covid and the gift giving in the form of stimulus as well-intentioned as it is, what happened to, I guess the amount of money, the purchasing power, what people could do with the gift? I mean with the amount of inflation we've had, it seems like it is maybe not entirely gone, the value of what that could buy initially, but it's so much smaller, I would think, than what was intended that it almost like it's like cutting off your leg when you're about to run a marathon. You just can't do that.

Eric Leeper (48:29)

If I'm understanding what you're saying, I take what you're saying to mean, and I don't quite get the marathon metaphor that, okay, we handed out a bunch of checks. Surely the inflationary effects of spending those checks have probably tapered off by now. Was that the gist of what you were saying? 

Juliette Sellgren (48:59)

More that if the fiscal and monetary sides don't work in tandem, if they move kind of in opposite directions, right, we're trying to give stimulus and that is the cause of inflation. But at the same time we're sitting there saying, well, you got to increase rates so people don't spend their money, so there's no inflation, but you've just told people they have a giant increase in income, so they can't afford to actually spend that money instead of saving, then it's not going to work, and the inflation is just going to, well inflate away the value of the money that you gave for stimulus. So it seems like it almost defeats the purpose of what the fiscal side was trying to do by not working in conjunction with the monetary side.

Eric Leeper (49:52)

Well, that's true. On the other hand, at the time that the stimulus checks were going out, the Fed had reduced the interest rate to zero. And so in that sense, at that point in time until they started to raise rates, the policies were consistent with each other. What you're putting your finger on is, okay, now let's assume that all the checks have been spent. Well, then why hasn't inflation come back down? You would think it would've burnt itself out by now. And here's the reason. The reason is because last fiscal year interest payments on the debt were over 800 billion. They were the third largest spending category larger than military spending. How have we financed those interest payments? We financed them by borrowing more. This is what's called a Ponzi scheme if you keep doing it.

(51:08)

Oh, no. And so what's happened is we're pumping more debt into the economy to finance those interest payments, which went up because the Fed was trying to fight inflation. But that then rate, if people don't expect that taxes are going to go up to pay off those bonds, then that makes the private sector wealthier and that then prolongs the inflation. So this is really in a nutshell why monetary policy alone cannot control inflation. It's going to try to control inflation by raising interest rates, raising interest rates, increases interest payments on the debt. If those interest payments on the debt aren't financed by moving from deficit to surplus in the budget and instead are financed by just further borrowing, well then what is going to happen is inflation's just going to have to keep going up because people are going to be feeling like, oh, we've got all this wealth now we're going to want to go out and spend it. So that is really why you cannot have a go it alone monetary policy. And I think that's what Volker understood, and I think more broadly, back in the seventies and early eighties, these issues were understood. It's only been in the last couple decades that people have forgotten macroeconomics and the fact that there's a government budget constraint that is just unrelenting, that has to hold, and as long as it holds, these two policies have to interact in some consistent manner.

Juliette Sellgren (53:15)

Thank you so much for taking the time to come on the podcast and for sharing all that with me and with my guests. I've learned a ton, and I know they will from this as well. So thank you so much. I have one last question for you, and that is, what is one thing that you believed at one time in your life that you later changed your position on and why?

Eric Leeper (53:40)

When I was in college, I was a libertarian and I found it very liberating, if you'll excuse the pun, because it made everything seem so simple. And over time it didn't happen immediately. But as I went through graduate school and sort of looked around the world a little bit, what I realized was that, yeah, that's a nice ideal, but it really seems to treat the world as this frictionless environment. And whether we like it or not, the world is full of frictions, and so I've kind of moved away from that. I still have some of those tendencies, but some of the more ludicrous aspects I think I have given up on.

Juliette Sellgren (54:59)

Once again, I'd like to thank my guests for their time and insight. I'd also like to thank you for listening to the Great Antidote Podcast. It means a lot. The Great Antidote is sound engineered by Rich Goyette. If you have any questions, any guests or topic recommendations, please feel free to reach out to me at Great antidote@libertyfund.org. Thank you.