Read on Twitter
Many great points here, though personally am not ready to abandon "monetarism" as my provisional theory of (trend) inflation. https://twitter.com/VMRConstancio/status/1284549107990888452
Monetarism explains price-level as being determined by supply of some nominal asset relative to demand for that asset. The inflation rate then determined by the relative growth rates in supply and demand of these objects. There are two main issues to deal with here.
First, what is the appropriate nominal asset? I think, to first approximation, it may be useful to view all UST as "money" for theory of inflation. Second problem is we cannot directly observe "demand" for money. We can see supply. We can see price. Cannot see demand directly.
But with some religion (supply/demand), we can make inferences. Low inflation, low (and stable nominal interest rate) despite rising supply of USTs can be explained by (form sign of the cross here) by demand for USTs growing more rapidly than supply.
Before you scoff at my religion, take time to evaluate your own religious beliefs. Phillips curve proponents appeal to their unobserved "natural rate," for example. Most (if not all) theories appeal to some non-observable "dark matter." Nothing to be ashamed of. Just admit it.
Now, does this theory sound plausible? What evidence can we bring to bear on the claim that the demand for USTs has been growing rapidly? I think there's a lot of anecdotal evidence available. First, since the 1970s and esp. 1980s, demand for USTs grew rapidly as a form of
collateral in credit derivative markets and in repo markets. The emerging markets crises in 80s and 90s led to added foreign demand (esp. by China) for USTs as safe store of value. The 2008-09 financial crisis wiped out large supply of "safe" private-label MBS collateral and
USTs valued as "flight to safety" vehicle. The European crisis further augmented demand for safe assets. The most recent push came from Dodd-Frank and Basel III both of which greatly spurred on growth in demand of UST for regulatory purposes. Finally, there's been massive
global growth in dollar-denominated financial products, which further generates demand for USTs. Any time there's a crisis in the world, UST yields dip --> a global "flight to safety" vehicle. How do foreigners acquire USTs? Demand should push yields down, and it does, but
what if yields close to zero? The only way for *real* supply of USTs to rise (for a given nominal supply) is for price-level to fall. That is, global demand for USTs is disinflationary. The way China ultimately acquires UST is by exporting goods to U.S. So, what do we see?
We see (1) persistent U.S. trade imbalances (associated with exorbitant privilege), (2) USD appreciation, (3) disinflation (as price of imports decline, since foreigners willing to buy US paper by cutting their prices). No wonder measures of domestic inflation no longer
tied to measures of domestic slack. The USD/UST is a global currency. Demand for the product continues to grow. But so does the supply (U.S. fiscal deficits). So the question for me is how long can this go on without something ultimately giving (i.e., higher inflation)?
Finally, if my pet theory is incorrect, then great! My recommendation in this case is to cut taxes to zero, increase monetary transfers to citizens, keep interest rate pegged at zero. If persistently large deficits do not ultimately lead to inflation, why not do it?
I love free lunches as much as the next person.
