MNI INTERVIEW: Fed-Treasury Accord Needed On Debt - Cochrane

The Treasury and the Federal Reserve need a new accord specifying who is in charge of the maturity structure of government debt, John Cochrane, a senior fellow at the Hoover Institution and former Fed adviser, told MNI. 

"One place where I do think there needs to be a better accord is on the maturity structure," he said in an interview. "We certainly need to get it straight who's in charge of the maturity structure."

Fiscal and monetary policy "have to act together," Cochrane said. "Institutional separation is important, and putting the Fed as part of the Department of the Treasury is not a very good idea."

The Treasury issues long-maturity debt because it wants to protect itself against interest rate increases. When it was engaged in quantitative easing, the Fed bought this long-term debt and issued overnight debt, said Cochrane, a former member of the New York Fed's Financial Advisory Roundtable. "The government as a whole, through this significant shortening of the maturity structure, has created a situation in which any increase in interest rates puts the U.S. in a precarious fiscal position."

"We have to face the reality that fiscal and monetary policy are more intertwined than we have thought. When you have 20% debt to GDP, they can kind of go their own way. The Fed can take care of inflation and fiscal policy can repay its debt," he said. "But the world is different. At 100% and more percent of GDP, they start to have to act together."

The Treasury-Fed Accord of 1951 allowed the central bank to end nearly a decade of pegging the interest rate on government debt. Kevin Warsh, a contender to be the next Fed chairman, has said there needs to be a new accord between the Treasury Department and U.S. central bank. (See: MNI POLICY: Warsh Could Reshape Fed On Rates, Communication) 

FISCAL DOMINANCE 

Cochrane downplayed concerns that the U.S. economy will see inflation due to the Trump administration's signature tax legislation, which the non-partisan Congressional Budget Office said will add USD3.4 trillion to the debt over the next decade. "Relative to people's expectations of what was going to happen. I don't see it as being particularly big either way." 

The United States is already in a state of fiscal dominance. "We're always in fiscal dominance, and that word gets vastly overused and it means 10 different things to 10 different people," he said. (See: MNI INTERVIEW: Fiscal Dominance To Fan US Inflation-Leeper) 

"Where does stable inflation come from? It comes from faith that U.S. debt will be eventually paid off and not inflated away. So I think even no inflation is a sign of good fiscal dominance, and inflation is a sign of fiscal pressures that there's not much really the Fed can do about."

"My view is what happened in 2021, 2022 was just a classic fiscal blowout causing inflation that the Fed even had it wanted to contain that inflation, which it didn't, the Fed would have had real trouble in stopping that from happening," Cochrane said. "Fiscal policy has to sober up if we don't want to have a lot of inflation."

President Donald Trump has explicitly tied his desire for lower interest rates to interest rates costs on the debt. 

"The concern with keeping down interest costs on the debt goes back centuries," Cochrane said. "That's what governments with a lot of debt have always done. We're back to classic issues, rather than some brave new world. That doesn't make those classic issues any easier."