John Cochrane Has the Most Convincing Take on Quantitative Easing I’ve Read So Far

by Reihan Salam

I’m eager to read the various responses to Cochrane’s take, but I greatly profited from it. Cochrane is a really lucid writer. His essay on fiscal stimulus, very salient in light of the tax deal, is superb.

Many of Cochrane’s intellectual antagonists (you know them well) engage in a great deal of hand-waving and ad hominem attack, e.g., all serious people believe X, you’d have to be a crazy reactionary to believe Y, etc. Cochrane is no wallflower and he gives as good as he gets, but he is careful to walk you through his assumptions, giving you the opportunity to accept or reject them. I like his style. 

Here is how Cochrane starts:


In November, the Fed started its new “quantitative easing program.” The Fed will buy up to $600 billion of long-term government bonds, putting $600 billion of extra money in the economy. Defenders think this is the key to reducing unemployment and breaking the economy out of its doldrums. Though the Fed’s motives were initially unclear, Chairman Ben Bernanke’s Dec 5 interview on CBS 60 minutes made it clear that fighting unemployment is a crucial motivation. Critics think this is the first step to out-of-control inflation, dollar devaluation, and a trade war.

Neither is right. 

And here is where he winds up:

A sudden deflation is bad, because it hurts borrowers, just as a sudden inflation is bad because it wipes out savers. But zero inflation, or even a slow, steady, and widely expected deflation, are in fact much better in the long run. The financial system is much healthier with bundles of cash lying around, at no interest cost, than if everyone is engineering clever, but ultimately fragile, cash management schemes. The main argument for higher inflation and consequently higher nominal interest rates is that it gives the Fed more power to run the economy by occasionally lowering rates, i.e. to go back to driving the car by slightly starving it of oil, and then artfully adding a quart when needed. Given what a great success that’s been lately, maybe trading a more fragile financial system for greater Fed power isn’t such a good idea after all.

But it is the arguments in-between that are the most valuable, so go read them.

The Agenda

NRO’s domestic-policy blog, by Reihan Salam.