Inflation Is NOT The Most Significant Factor Determining Bond Prices

One of the pieces of pseudo-science that floats around in popular discussion of bonds is the belief that bond investors are deadly afraid of inflation. In particular, bonds "lose money" every time the Consumer Price Index rises -- which is most months, in most developed countries. As far as I can tell, this is the legacy of some Economics 101 textbook story that has been passed on from "expert" to "expert" over the decades.

The correct answer is that nominal yields largely reflect the expected path of the short-term nominal policy rate, and is thus a reflection of the central bank's "reaction function." (At this point, some people will jump in and start going on about the term premium. However, unless we using an obviously dysfunctional term premium model, the term premium is only a small deviation from the fair value determined by rate expectations.)

Publishing Update

The manuscript for Recessions: Volume I is now in the final editing pass. The actual appearance in online stores will take at least a month, but possibly closer to two months. I prefer to release the ebook and paperback editions simultaneously, and as I discovered the hard way, I need to see a printed proof of the paperback edition. (The chart image files were mangled by a processing step at the printers.) (The Amazon paperback/ebook editions will likely appear the same day, other stores have variable processing lags.) The book is longer than my previous books (58,000 words), although it is still shorter than most books you find in bookstores. (Novella length versus novels, using fiction terminology.) This book is somewhat specialised, and so the pricing will be somewhat higher than my earlier books.

Note: I have an article half-written on inflation and bond pricing that will either appear later today or tomorrow. I will return to Scott Fullwiler's article on debt sustainability this weekend (I hope). This will be a focus of the chapter on Fiscal Policy. 

Central Bank Objective Functions

One topic of research that keeps popping up is the question of what the central bank objective function should be. In simpler terms, what is the target of the central bank? (At present, most central banks have an inflation target, possibly with secondary objectives.) This is a preoccupation of many "conventional" economists -- those in the neoclassical tradition, as well as those that are somewhat out of the mainstream (e.g., Market Monetarists are pushing for a Nominal Gross Domestic Product Level Target (NGDPLT). If one sticks to the usual Modern Monetary Theory (MMT) story, this is not really a topic of interest. However, even if I take my MMT hat off, I think these discussions are putting the cart before the horse.

Another Pause...

Various distractions means that I will wait until the weekend until my next piece. Unless something interrupts, it will be about Scott Fullwiler's piece on "sustainable" fiscal policy. If the reader wishes, they can read ahead and be ready to pepper me with comments...

Fullwiler, Scott T. "The debt ratio and sustainable macroeconomic policy." World Economic Review 7 (2016): 12-42.

The pandemic news (and American politics...) appears to be the big story right now. One of the advantages of not pretending to be a forecaster is that I do not have to waste my readers' time with my takes on the economic effects of viruses. (Pandemics are bad, and I do not see what else I can say.)

Functional Finance Roots Of MMT

I have been writing online for over six years. and my experience is that almost all of the discussion around Modern Monetary Theory (MMT) involve basic principles of Functional Finance. Functional finance was a school of thinking within early post-World War II Keynesian economics. For a number of reasons (mainly political), Functional Finance disappeared from discussion -- until proponents of MMT revived the ideas. The online debates (including opinion pieces from mainstream academics) bounce around Functional Finance ideas. This is somewhat unusual, as the theoretical dissent around the basic Functional Finance concepts used is not very strong.

MMT And Fiscal Policy: Radical Or Not?

Most public debate around Modern Monetary Theory (MMT) revolves around fiscal policy. This is not too surprising, as this is largely where political economy concerns crop up when discussing MMT. However, the emphasis on fiscal policy makes discussions of the MMT debates quite awkward. There is a large divide between the debate in modern economic theory, and the debate in popular discourse.

If we look at economic theory, there are no credible challenges to the MMT story at present; at most, one can debate terminology. Since many economists are keen to present economics as a highly mathematical, scientific discipline, getting into long-winded, arcane debates about linguistic issues does not fit the narrative. However, there are plenty of reasons for there to be a strong debate in popular discourse: not everyone agrees on the proper role of government in the economy. However, we cannot appeal to any formal theory to adjudicate the popular debates.

Limited Passthrough From Exchange Rates To Inflation: Canadian Example

The inflation story in Canada and the United States has not been particularly exciting for some time, and I am not in a position to argue that this will change any time soon. I just want to update a chart that I think is extremely useful when discussing the alleged external constraint on floating currency sovereigns. As seen above, even Canada -- a small floating currency sovereign with a economy highly open to external trade -- has extremely limited passthrough from exchange rate movements to (consumer price) inflation.