Voices of Freedom - Interview with John Cochrane

Episode Date: February 8, 2024

An Interview with John Cochrane, the Rose-Marie and Jack Anderson Senior Fellow of the Hoover Institution at Stanford University While the staggering levels of post-pandemic inflation have gone down, Americans continue to say they feel pinched by high prices. All eyes are on the Fed for hints at what they may do to reduce inflation and ease the cost of housing and consumer goods. Adding to the economic uncertainty is the backdrop of an election and a looming debt crisis. Stanford economist John Cochrane is our guest on this episode of Voices of Freedom. An expert on the drivers of inflation, his recently published book provides vast insight into the economic consequences of the government spending money it doesn’t have. He shares his thoughts on what 2024 has in store for the economy. Topics Discussed on this Episode: ·         What economic data indicates vs. how Americans feel about the economy ·         The impact of the 2024 election on the economy ·         Why home ownership isn’t the best investment ·         America’s debt crisis and how to rein it in ·         Why the income tax should be eliminated and the tax code simplified John Cochrane is the Rose-Marie and Jack Anderson Senior Fellow of the Hoover Institution at Stanford University. He also pens the popular blog, “The Grumpy Economist,” on Substack and is the author of numerous publications and articles on monetary policy, finance, the economy and other topics. His latest book, The Fiscal Theory of the Price Level was named one of the Economist’s Best Books of 2023. John is also a 2023 Bradley Prize winner.  

Hello and welcome to Voices of Freedom, a Bradley Foundation podcast. I'm Rick Graber, President and CEO of the Bradley Foundation. On the podcast, we'll explore issues that affect our freedoms with a focus on free enterprise, free speech, and educational freedom. So let's get started. It's a new year, and in this new year, there will inevitably be lots of questions about the economy. Questions such as, will we continue to see a decline in inflation? What will the Fed do about interest rates? Will there be disruptions in the supply chain?

On top of that, it's an election year, so economic issues will almost certainly be even more top of mind than usual. Here to help sort all this out is one of America's leading authorities on the economy. John Cochran is the Rosemarie and Jack Anderson Senior Fellow of the Hoover Institution at Stanford University. He also pens the popular blog, The Grumpy Economist, which can now be found on Substack. John is the author of numerous publications and articles on monetary policy, finance, the economy, and other topics. His latest book, The Fiscal Theory of the Price Level, was named one of the Economist's Best Books of 2023. John is also a 2023 Bradley Prize winner. John, welcome. It is great to see you. Welcome back. It's a pleasure. Good to see you again. John, it's been a little less than a year since we last chatted. And at that time,

you had just published The Fiscal Theory of the Price Level. It's a really impressive book that takes a deep dive into how debt and deficits cause inflation. How's it going? How's the book been received? Fairly well, I think. I've made some inroads in surprising places. As an academic, nobody's written me to say I've found something horribly wrong in Section 5, so that always feels good. And, of course, I was very lucky to write a book about how debt and deficits cause inflation, just as the government printed up some massive debt and deficits.

Exactly. So it's so obviously kind of the right answer for what just happened. I think I got a big marketing event out of the federal government. Thank you. Let's talk about inflation. Americans, and I think with really good reason, continue to be concerned, even though the rate of inflation has come down from the prior year. It certainly is the number one reason people are saying that the economy is just not good. In fact, it's bad.

What explains in your mind the discrepancy between the current level of inflation and how Americans are viewing it. Yeah, it's, you know, the way you phrased the question, I'm reminded of lots of New York Times articles I read sort of say, why don't those dumb little deplorables figure out that things are better than they really are? Inflation is the rate of change of prices. So inflation has come down, but prices are still much, much higher than they were before the pandemic. And so people look at the level of prices and they are correct. Prices are much higher and they have not come back. And if you have not gotten a wage increase commensurate with the amount of inflation, you are worse off than you used to be. So people have that wisdom. So just because it isn't getting worse right now as fast as it used to be, I sort of side with the people. They're right. Now, things could be worse. The rate of inflation could be high and things

could be getting worse at a faster level. But that's the fact. Prices are higher than they used to be and people are, they are correct about that assessment, and they are unhappy about it. I mean, it's really no more complicated than going to the grocery store, right? That hits home just about every week for most of us. One of the deepest places where our economic discussions get confused is between levels and growth rates. People say, oh, China's growing so much faster than the U.S. Yeah, but they started out really poor, so they're still behind us in terms of levels.

The level of prices is higher, even though the growth rate is not as much as it used to be. Well, keep those things separate. That's the economics lesson for today. Another looming economic question, of course, is what's the Fed going to do about interest rates, if anything? What's your take, especially when you consider that this is an election year? I suppose in theory, election year shouldn't matter, but I think they probably do. Oh, I think our Fed is pretty darn good about being nonpartisan, at least it has been so far. We'll see how much the end of democracy rhetoric gets to the Fed. The Fed is much more predictable than the rest of the economy, though. So I don't

know really what's going to happen to inflation or output or employment, but I know pretty darn well what the Fed's going to do in the sense of I know how they're going to react to things. If inflation goes down below 2% and sits there, the Fed will lower interest rates, especially if the economy looks weak. If inflation picks back up again, the Fed is not going to get caught with their pants down again. They're going to raise interest rates fairly quickly. So the Fed will follow what happens inflation fairly predictably. That's the one thing I can bet on. What that all means, good luck. Another economic pain point for Americans is the housing market. And you've

got some really interesting thoughts on this, John. Many homeowners who want to move are staying put because they've locked in really attractive mortgage interest rates, probably locked in a few years ago. But that in turn creates a lack of inventory, which in turn drives up home prices at a time when mortgage rates are already high, at least relatively high. And the bottom line is home ownership is simply out of reach for many, especially would-be first-time homebuyers. But you have a really interesting take on home ownership. You've said it's a bad investment, which is almost sacrilegious.

Why is that? Are you just being a grumpy economist? So you, T, have three questions. So I'm just warning you, you're going to get a little bit of a longish answer on this one, because there's three very interesting questions. The first is this issue about the mortgages. So if you buy a 30-year fixed rate mortgage, that is an interesting interest rate bet. You now own an interest rate derivative. You didn't know that. Because it gives you the right, if interest rates go down, you have the right to refinance at a lower rate.

If interest rates go up, then you're sitting pretty because you can pay this nice low interest rate on your house and not worry about interest rates going up. But that only holds so long as you sit in the house you own. I'm just restating your question. If you want to move, you have to pay the new higher interest rates on a new house. Now, why in the world can't you take the mortgage you had on your own house and say to the bank, look, I want to keep paying back that money I borrowed. I want to secure it with a different house. That would make perfect sense, wouldn't it? And it's an interesting fact that you can't. Now, that's the source of the problem. People, if they want to move, they lose this wonderful, they have to throw away the bet that they just won against the banks that interest rates will go up. Other countries allow you to take your

mortgage with you. Other countries allow you to buy it back from the bank at a nice low price and take the financial benefit with you. So there's no financial reason why we have to tie winning a bet on interest rates against the bank to sitting in one particular house. And I think it's part of the overregulated financial system. The rules are put down by what Fannie and Freddie will take. Because Fannie and Freddie now run basically the whole mortgage system. The rules are put down by what Fannie and Freddie will take, because Fannie and Freddie now run basically the whole mortgage system. So only conforming mortgages can be securitized anymore. And the last time there were innovations to that financial product was in the 1930s. So it's one example of how regulations and government interference can really slow down innovation in markets. Now, your second question, homes are out of reach for the average person.

The little bit of supply that isn't there because people can't move isn't really the center of the problem. The center of the problem there is building restrictions. It's very hard to build houses. Therefore, houses sell for much more than the cost of new construction. That's really the fundamental issue. Why does America not allow people to build more housing in the places where people want to live? That's why it costs too much. I'm actually heartened here because now that the sort of left-wing progressive end has figured this out and are saying his heretical things like let people build more houses. Another thing our policy does is massively subsidize home ownership on the notion that

owning a home is the key to building intergenerational wealth or whatever. Houses are terrible investments. Houses are a place to live. They're a consumer durable. But if you want to build wealth, build it in the stock market. And I think our public policy would be much better served by not subsidizing homeownership so much and instead having people build wealth through financial means rather than buying a big, a big, highly levered investment that's subject to a lot of idiosyncratic risk. So would your advice to all these would-be first-time homeowners be just keep renting? Well, my advice to public policy would be stop subsidizing homeownership.

Now, we live in a place where homeownership is heavily subsidized. Yes. So when you buy a house, you get subsidies from the taxpayer. When you buy a stock, they tax you on it. So there's an artificial incentive to buy houses. So that's less personal finance advice. But on the personal finance advice side, I think it is underrated how good the returns are on stocks over the very long run, even relative to houses, even with the current set of subsidies for home buying. a little bit. It's at a record high, $34 trillion. No one is doing anything about it to rein it in, whether you're a Republican, a Democrat, or something in between. How long is it going to take before all government revenues coming in are consumed by entitlement payments and interest?

This just doesn't seem sustainable, is it? It is not. Now, it's not true that no one is doing anything about it. There's lots of noise about the debt, but you are exactly right that the kind of sit down, get it together, permanent bipartisan consensus to fix a long-run problem that this needs is not happening, as you know, because we're tearing each other apart. Immigration debt, these are the kinds of things that require a structural fix that lasts over multiple administrations. You can't just write an executive order about the debt. So that is certainly not happening in Washington. And yes, the trajectory is interest payments consume more and more. Unreformed entitlements consume more and more.

There's not anything left for anything else. Buying other stuff is outrageously more and more expensive. You know, hundreds of billions of dollars to do basic things. And eventually that which is unsustainable will not be sustained. Debt can only end in massive tax increases. I don't even think that'll work because you'll kill the economy. Default inflation or horrendous and very painful cuts. The thing I worry about actually more is not just this thing playing out until it can't play out anymore, but being so in debt reduces America's capacity for borrowing. So I think the real problem is what happens in the next crisis.

China blockades Taiwan. All Pacific trade comes to a halt. Massive financial and economic recession. Uncle Sam wants to borrow $5 trillion, $10 trillion, bailout, stimulus, all the stuff we do. Plus this time, actually buy some military goods after we discover that all our missiles and bullets are gone after the first week. Well, if you're in such a debt problem and such a deficit problem, are markets really going to shovel out another $5 to $10 billion of new savings to lend to Uncle Sam when there's no plan for paying it back? That's the scenario where I

think the trouble comes. Well, when you talk about tackling the debt problem in this country, I mean, it seems to me that that has to include a conversation about entitlement reform. And presidential candidates aren't willing to touch it. Congress isn't really willing to touch it with a few exceptions. And something's just got to give at some point or another. What are some reasonable steps we could take to put us on a better path, like raising the age limit on social security? Is that just a drop in the ocean or could that have an impact? The outlines of this are pretty straightforward. And I like the word you use, not entitlement cuts, entitlement reforms. We can give money to the people who really need it more efficiently.

Yes, raising the retirement age. We live longer. And we have a worker shortage. People should be working longer. Changing the way it's indexed for inflation makes an enormous difference. Constraining some of the out-of-control health expenditures, half of its health, half of its retirement. That's fairly straightforward to do. You know, as far as a matter of policy, just voucherize it. How much are we going to support? Here, it's $12,000 a voucher to buy yourself some health insurance. That will work great.

Tax reform, it's possible for our government to raise more money at lower, less distorting rates and fix the tax code and most of all, economic growth. The best way to make tax revenue is not by higher tax rate, but by a higher taxable income. So just get out of the way and let the economy grow does wonders. This is not a hard budget problem. These are self-inflicted wounds that any bipartisan commission could fix very quickly if there was the will to do it. Let's talk about taxes. Tax season is here. It's an annual reminder of just how ridiculously complicated our tax system is. You recently wrote about income tax paradox, which included a historical account of the tax on income and wealth. Let's start with a really fundamental question. Why does the government tax our income and should it? Exactly. So I'll channel a little bit that,

why do we tax income? When you think about it, it doesn't make any sense whatsoever. And the answer is because it's there. So my first taxation is the government grabs what it can. And in 1907, when it realized it needed more money than the tariff. Previously, the federal government was was supported by tariffs, which is why we didn't have tariffs because of trade theory or anything. We had tariffs because it's real easy to grab money when stuff goes in and out of ports. And we substituted it with an income tax because that was the thing that the government could do in 1913 to raise a lot of money. But it doesn't make economic sense, and it leads to the kind of

crazy complexity that we have in the tax code. So my theme in all of this is the little old lady who swallowed the fly, and then she swallowed the spider to swallow the fly and so on and so forth, and now she's eating the horse. And that's really where the income tax goes. So once you have an income tax, then you have to have a corporate income tax. Otherwise, people will incorporate themselves, it goes you know one step after another kind of inexorably till you get to the craziness we have now and that's why I was proposing the economically sensible thing is a consumption tax

that can be a much lower rate you don't have to tell the government how many children you have what kind of house you live in you don't have to keep track of all of your expenses back to the beginning of time as you do for the estate tax. So really preserves privacy, made much better economic incentives, and we can do it now in a way that we couldn't do in 1913. Really interesting. But some of the conversation we're hearing now, it seems to me, makes it even worse. Supreme Court heard a case last month that, depending on which way they go, could result in a tax on unrealized gains. I guess that means home appreciation as well. And if that occurs, the tax system is just even worse. It's even more onerous, hard as that might be to believe.

Yeah, it leads to a fight with the, you know, you fight with the assessors now. We have a wealth tax. It's the property tax. And every year you fight with the assessor for what your house is worth. Yes, we do. Imagine doing that for every single one of, you know, privately held businesses and all the rest of it. It's a nightmare. And it's a problem because the cash isn't there. We tax realized gains, back to the very simple one. When you realize a gain, there's some cash. It's a nightmare. And there's it's a problem because the cash isn't there. We tax realized gains back to the very simple one. When you realize a gain, there's some cash. It's easy for the government to grab it. The unrealized gain is unrealized. What are you going to pay the tax with? We already have that problem with with the state taxes.

So and one more immense intrusion into your privacy. I was reminded there was the letter from Congress to the Treasury this last week that was complaining about the Treasury forcing banks to disclose purchases by individuals that were to try to get after political purposes with the Canadian truckers. I mean, the intrusion of the government into your personal affairs is politically dangerous, as well as economically really inefficient. I'm sure you've looked at this closely. I assume that your argument is the economic impact of a simpler tax code would be significant, right? Yes. It is funny, though, in economics,

they say economists have, you know, economists have a sense of humor because we use decimal points, but forecasting exactly how much growth and profound change in the tax system do. I don't know, but you just look at it, the massive complexity of it, the amount of our corporate structures that are just set up to avoid taxes, not to provide better goods and services, and the implied very high marginal rates, the all-in top marginal rate in

California, earn an extra dollar, how much extra stuff do you get, is on the order of 70%. So it's where the tax bites, it has big economic disincentives. So having those incentives, and the consumption tax is especially nice incentive because it says we'll get them down at the Porsche dealer. So you don't bother taxing income when it's earned. You don't bother taxing income when it's invested and left invested and supporting businesses that produce great stuff and employ lots of Americans. You get them down at the Porsche dealer when they spend it.

And that's economically the least distorting place to get it. Makes so much sense. Let's wrap things up, John. Last year, you published a seminal book on inflation at a time when inflation, as you mentioned, was the top economic concern. Fantastic. You won a Bradley Prize. 2023 was not a bad year. What's next for you? Oh, I have lots of projects going. Partly I'm following up, you know, the fiscal theory of the price level was just the beginning. So there's all sorts of puzzles that I don't understand. And I know nobody understands basics of how inflation works.

How does the Fed control inflation or does the Fed control inflation? It's a really fascinating field because there's so much pretense of detailed knowledge with complicated models. But when you tear it apart, nobody really knows how it works. So I'm still working on money and inflation issues. And I'm also, I can admit to you now, I felt like I won the Bradley Prize prematurely. I put together in my speech for the Bradley Prize, sort of the prospectus of my next book, which is to try to unite all the things we've been talking about here and in one very accessible, how basic principles of freedom, free markets, but freedom and incentives can fix all of our problems. So just like the talk we have here, this needs to be a book.

And that's my next big project, too. Fantastic. John Cochran, thanks so much for your time today and thanks for your great work. Join us on Apple Podcasts, Spotify, or wherever you get your podcasts for our next conversation on issues impacting our freedom and America's foundational principles. And make sure to subscribe so you don't miss an episode. I'm Rick Graber, and this is a Bradley Foundation podcast.