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Perpetuities, Debt Crises, And Inflation

John Cochrane profile picture
John Cochrane


  • My proposal to fund the US with perpetuities comes from a paper.
  • Inflation is not about money anymore - the choice of money vs. bonds.
  • If we have inflation, the mechanism will be very much like a run or debt crisis.
  • I argue the US should quickly move its debt to extremely long maturities. The best are perpetuities - bonds that pay a fixed coupon forever, and have no principal payment.

My brief exchange with Markus Brunnermeier at the end of a COVID-19 talk attracted some attention, and merits a more detailed intervention. Gavin Davies at FT made some comments (more later) as did the Economist.

My proposal to fund the US with perpetuities comes from a paper, here. (Sorry regular readers for the repeated plug.) The rest is standard fiscal theory of the price level, spread over too many papers to give one more plug.

There are three main points. First, inflation is not about money anymore - the choice of money vs. bonds. Money - reserves - pay interest, so reserves are just very short-term government bonds. Inflation is about the the overall demand for government debt. That demand comes from the likelihood of the debt being repaid, and the rate of return people require to hold debt.

Second, if we have inflation, the mechanism will be very much like a run or debt crisis. Our government rolls over very short-term debt. Roughly every two years on average, the government must find new lenders to pay off the old lenders. If new lenders sniff trouble, they refuse to roll over the debt and we're suddenly in big trouble. This is what happened to Greece. It's what happened to Lehman Bros. In our case, our government can redeem debt with non-interest-paying reserves, resulting in a large inflation rather than an explicit default.

2a, a run is always unpredictable. If you knew there would be a roll-over crisis next year, you would dump your government bonds this year, and the run would be on. There is a whiff of multiple equilibrium too. Our debt is nicely sustainable at 1% interest. If interest rates go up to 5%, we suddenly have north of $1 trillion additional deficits, which are not sustainable. The government is like a family who, buying a home, got the 0.1% adjustable rate mortgage

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John Cochrane profile picture
John H. Cochrane is the AQR Capital Management Distinguished Service Professor of Finance at the University of Chicago Booth School of Business. His recent finance publications include the book Asset Pricing, and articles on dynamics in stock and bond markets, the volatility of exchange rates, the term structure of interest rates, the returns to venture capital, liquidity premiums in stock prices, the relation between stock prices and business cycles, and option pricing when investors can’t perfectly hedge. His monetary economics publications include articles on the relationship between deficits and inflation, the effects of monetary policy, and on the fiscal theory of the price level. He has also written articles on macroeconomics, health insurance, time-series econometrics and other topics. He was a coauthor of The Squam Lake Report. He writes occasional Op-eds, and blogs as “the Grumpy Economist” at johnhcochrane.blogspot.com. Cochrane is a Research Associate of the National Bureau of Economic Research and past director of its asset pricing program, a Senior Fellow of the Hoover Institution at Stanford University, and an Adjunct Scholar of the CATO Institute. He is a past President and Fellow of the American Finance Association, and a Fellow of the Econometric Society. He has been an Editor of the Journal of Political Economy, and associate editor of several journals including the Journal of Monetary Economics, Journal of Business, and Journal of Economic Dynamics and Control. Recent awards include the TIAA-CREF Institute Paul A. Samuelson Award for his book Asset Pricing, the Chookaszian Endowed Risk Management Prize, and the Faculty Excellence Award for MBA teaching. Cochrane currently teaches the MBA class “Advanced Investments” and a variety of PhD classes in Asset Pricing and Monetary Economics. Cochrane earned a Bachelor’s degree in Physics at MIT, and earned his Ph.D. in Economics at the University of California at Berkeley. He was at the Economics Department of the University of Chicago before joining the Booth School in 1994, and visited UCLA Anderson School of Management in 2000-2001. In addition to research and teaching, Cochrane is a competition sailplane pilot and windsurfs. He lives in Chicago with his wife Elizabeth Fama and children Sally, Eric, Gene and Lydia. For more information, please see Cochrane’s website, http://faculty.chicagobooth.edu/john.cochrane/

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Comments (3)

Simpler just to issue $trillion dollar coins. Central banks are the only buyers anyways.
David de los Ángeles Buendía profile picture
Hello Dr. Cochrane @johencochrane ,

There have been three periods of intense inflation in the history of the United States, during the Civil War, World War I, and the Vietnam War and in the periods immediately following each war (there were wageprice controls in place during World War II, the Korean War, and for a short time near the end of the Vietnam War). The Great Inflation of 1965 – 1985 [1] was produced by the deficit spending to support the Vietnam War. The end of the war the associated deficits were the main reason for subsidence of inflation. The Nixon administration introduced wage and price controls from 1971 to 1974 because inflation was so intense at that time.

None of these conditions exist at the moment, the economy is contracting dramatically. This reduces demand for goods and services. When demand falls but supply remains constant, prices fall. As prices fall, providers of goods and service reduce the supply of goods and services, which generally reduces employment. When people lose their jobs, they buy less, causing a further reduction in demand. They cycle of falling prices, production, and employment is known as a Deflationary Spiral [2].

To say that inflation is highly unlikely in this situation is an understatement.

[1] http://bit.ly/ZBwRIT

[2] fraser.stlouisfed.org/...
Who would buy the perpetuities? The Fed? We can accomplish the same thing with yield curve control perpetually. In fact we probably will.
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