It’s difficult to count the number of mainstream macro theories that we’ve debunked over the past few years. Many long-used relationships and correlations have been upended by record monetary and fiscal stimulus during the pandemic, a wave of early retirements by Baby Boomers, and interest-rate hikes off ultralow levels. We’ve been busy shooting them down since early 2022.
Taking great pains to keep it short, below is a review of the 10 widely held macro theories that haven’t held water and the reasons that they’ve led many astray:
(1) Modern Monetary Theory. Melissa and I have said before that Modern Monetary Theory (MMT) isn’t modern, isn’t monetary, and isn’t a theory. MMT’s proposition that a government that borrows in its own currency can finance its spending at will with more debt lost credibility as inflation soared in 2022 and 2023. However, MMT seems to be working now that inflation has subsided. Even as the federal deficit remains very wide—and the consensus is that after the November elections, it will continue to widen—inflation has moderated to near 2.0% (Fig. 14 below and Fig. 15 below).
MMT’s zealots within the current administration have been essentially using a blank check to load up on fiscal stimulus even though the economy is already growing faster than 3.0% y/y. The interest cost on the federal debt is increasing rapidly due to the record debt issuance and higher rates (Fig. 16 below).
It’s not the Fed’s job to lower rates to accommodate the government, as some have suggested, because that would lead to more inflation. The government instead needs to slow its pace of debt financing (Fig. 17 below). Without doing so, future generations will be saddled with a huge pile of debt that will hamper any stimulus efforts if and when there is a recession (Fig. 18 below).
(2) Inverted yield curve. According to our Credit Crisis Cycle theory, the inverted Treasury yield curve signals that bond investors are worried that higher short-term interest rates will cause a credit crisis and therefore a recession. Because the Fed and Treasury prevented a credit crunch from emerging as regional banks collapsed last March, the expansion was able to continue (Fig. 19 below).
(3) Disinverting yield curve. The Treasury yield curve has flipped positive in September, with the 10-year yield now roughly 15bps above the 2-year yield (Fig. 20 below). Historically, a recession has followed soon after such a disinversion—but only because the Fed was cutting interest rates rapidly to stem a crisis, which then morphed into a recession. This time around, the Fed is cutting rates as a preventative measure.
