University of Chicago’s John Cochrane has a new NBER paper out that is sure to generate some debate. He outlines the following scenario of how the U.S. could conceivably go from the current state of affairs to a situation of high inflation:
Will we get inﬂation? The scenario leading to inﬂation starts with poor growth, possibly reinforced by to larger government distortions, higher tax rates, and policy uncertainty.
Lower growth is the single most important negative inﬂuence on the Federal budget. Then, the government may have to make good on its many credit guarantees. A wave of sovereign (Greece), semi-sovreign (California) and private (pension funds, mortgages) bailouts may pave the way. A failure to resolve entitlement programs that everyone sees lead to unsustainable deﬁcits will not help.
When investors see that path coming, they will quite suddenly try to sell government debt and dollar-denominated debt. We will see a rise in interest rates, reﬂecting expected inﬂation and a higher risk premium for U.S. government debt. The higher risk premium will exacerbate the inﬂationary decline in demand for U.S. debt. A substantial inﬂation will follow — and likely a “stagﬂation” not inﬂation associated with a boom. The interest rate rise and inﬂation can come long before the worst of the deﬁcits and any monetization materialize. As with all forward-looking economics, no obvious piece of news will trigger these events. Oﬃcials may rail at “markets” and “speculators.” Economists and the Fed may scratch their heads at the sudden “loss of anchoring” or “Phillips curve shift.”
Not being a macro guy, I will allow others more capable than myself to evaluate his claims; I’ll simply pass along the gated and ungated versions, step aside, and wait hopefully for an elucidating debate.