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How The U.S. Tries To Control Inflation
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I personally think we are right in maybe the biggest
bubble of my.
Career once the Fed came in.
People now expect the Fed's going to come in again.
The big challenge is raising interest rates enough
without tipping the economy into a recession.
People's expectations, their views of the future
inflation actually results in higher inflation.
That's the problem.
When you have a Federal Reserve that one cycle after
another, every time they have a crisis hit, they try
and solve the problem of overindebtedness by putting
more debt into the economy.
You look at the central bank balance sheets
exploding right now and you say there's going to be
inflation.
Stock market observers are sounding an alarm.
I personally think we are right in maybe the biggest
bubble of my career.
Investors have loaded up on risky assets like housing,
tech stocks and even cryptocurrency.
Asset valuations are somewhat elevated.
The cryptocurrencies that are really speculative
assets, I do think they are risky.
They're not backed by anything.
Many believe that the market problems started at the top
U.S. bank, the Federal Reserve, the Fed controls
all of the money in circulation. That includes
all of the money in your wallet and the coffers at
banks. They can print more during financial
emergencies.
Once the Fed came in.
People now expect the Fed's going to come in again.
For the last two decades, the U.S.
Central Bank has kept interest rates on loans as
cheap as possible.
They also bought bonds flooding the market with
emergency cash.
The balance of the Fed's bond portfolio has
crescendoed to nearly $9 trillion an all time high.
What's happened is the balance sheet has become
more of a tool of policy.
The Federal Reserve is using its balance sheet to
drive better outcomes.
The Fed's actions led the market to historic highs,
but some within the central bank believe that this bond
buying program needs to end.
The sooner, the better.
Analysts predict a 2 to $3 trillion wind down in the
Fed's bond portfolio over coming years.
Doing so would stabilize markets.
But there's a risk if the Fed drops its emergency
stimulus too quickly, it could spark a recession.
The big challenge is raising interest rates enough,
tightening policy enough to corral inflation without
tipping the economy into a recession.
Easier said than done.
History is not necessarily on their side.
So how did the Fed acquire nearly $9 trillion worth of
assets and can they sell them without breaking the
economy? The US government relies on its central bank,
the Federal Reserve, to manage the economy.
The Federal Reserve itself was created after a major
crisis. There was a financial crisis in 1907.
We didn't have a central bank and there was a large
study done that concluded that part of what we needed
to avoid these future crises was a central bank
that would be able to create more currency during
times of stress.
The Federal Reserve has proven itself repeatedly
over time, well positioned to be the first responder in
the face of any type of shock.
The Fed's most important tool is the federal funds
interest rate.
The Fed funds rate right now is between zero and a
quarter percent. That's as low as they can can go.
It is highly unusual to have interest rates close to
zero. Basically what the Fed does is it sets the rate
at which banks borrow money between themselves
overnight. Now, from that short term rate comes all
the other rates that people pay for in terms of mortgage
rates or home equity line of credit rates or
automobile loan rates.
But ultimately, all rates are set by banks and by the
market based off of that short term overnight rate
that the Federal Reserve.
Says central banks around the world have kept interest
rates low to stimulate further growth in the face
of unusual financial conditions.
In the US, bankers have resisted using negative
interest rates. Instead, they've delivered economic
stimulus with tools like the bond portfolio.
They keep track of the spending with a balance
sheet.
All banks have a balance sheet, they have assets and
liabilities. The liabilities are the currency
in circulation. The Federal Reserve notes it's a primary
liability on the asset side of the balance sheet.
Then the Federal Reserve has purchased a number of
things, including government securities, some
mortgages. It's all because you need to add back those
liabilities, that currency in circulation with assets.
The Fed has the power to create more money when the
financial system starts to break down.
For this reason, experts call it the lender of last
resort.
The lender of last resort was in many ways the
original function of the Federal Reserve.
We didn't want to have a central bank originally
because we were worried about there being so much
power aggregated in that way.
But we needed this function and so we might as well have
it put in place in a.
A way that allows oversight and accountability.
For much of its century long existence.
The Federal Reserve did not make much use of the
balance.
Sheet on 911.
It was a balance sheet of roughly 750 $800
billion, and that was the largest it had ever been at
that point.
Dr. Ferguson left the central bank shortly before
the housing crash took hold in 2008.
In that episode, nervous investors watching the real
estate sector started to pull out of the entire
market to prevent the full scale collapse of the
financial system. Federal Reserve Chair Ben Bernanke
authorized a large scale purchase of bonds, sending
the balance sheet rapidly upward.
The pundits called.
It quantitative easing.
Quantitative easing, quantitative easing.
Quantitative easing was this mechanism of trying to
to spur more credit creation.
And the core idea here was that by buying up safe
instruments, treasuries and agency mortgage backed
securities, they could spur even more accommodative
credit conditions, try to get more economic activity.
Investors buy bonds to generate a modest but
guaranteed return.
The U.S. Treasury bonds are perhaps the safest assets
out there. They're known as a riskless asset.
And most of the mortgages that the Federal Reserve is
buying are what's called conforming mortgages.
Very, very deep and liquid market.
Many traditional investors recommend using a portfolio
that balances these bonds against stocks.
But when the Federal Reserve steps into the
market, it's taking these safe bonds, making profits
on them fall for everyone.
That is going to make it, from the investor
perspective, more likely that they are ideally going
to be putting their capital work in ways that support
private innovation.
Holding such a large balance sheet of nearly $9 trillion
has contributed to this environment where a lot of
money is flowing into risk assets and you start to see
some crazy things.
Companies that really don't have much of a business were
able to go the IPO route in 2020 and especially in 2021
and raise a lot of money.
Those businesses ultimately fail.
There's going to be a lot of investors kind of left
holding the bag.
Markets have come to rely on the Fed's purchasing
patterns.
But by making the Federal Reserve so central in the
the efforts to get money to companies in the spring of
2020 and the summer of 2020, we did create an
overall environment where we did far more to to
backstop some really fragile financial
intermediaries. So if you were a large company,
regardless of whether you were a highly creditworthy
or a not so creditworthy large company, your ability
to raise money by issuing new debt over the past
couple of years has just been astounding.
The central bank took on nontraditional assets like
securitized mortgage loans.
To some, this has been controversial.
How many of you people want to pay for your neighbor's
mortgage that has an extra bathroom and can't pay their
bills, raise their hand?
How about we ask President Obama, are you listening?
The Federal Reserve warned markets that the time had
come to wind the balance sheet down that sent day
traders into a panic.
In the next year or sooner.
We are going to end quantitative easing.
We are going to end bond buying, we are going to end
the injection of new reserves that creates a
necessary money supply that ain't bullish for gold.
I'm sorry. The idea that one of the biggest buyers and
biggest holders of government debt in
particular, and mortgage backed debt would all of a
sudden stop being a buyer and potentially start being
a seller. That caused investors to to freak out.
And so they quickly backpedaled from that.
And that never really even came to pass.
For several years later, they started to slowly let
bonds that were maturing roll off the balance sheet.
Over time, emotions calmed and the balance sheet
plateaued. Ben Bernanke's plan had proved successful
and stock valuations were at a record high.
The central bank started to unwind the balance sheet
slowly before warning signs flashed again in 2019.
Toward the end of the 20 tens, strong market
conditions gave the Fed enough confidence to start
letting its bonds mature.
They didn't get very far before economic growth
really slowed sharply, and they once again start
cutting interest rates.
And that was in the middle of 2019 when unemployment
was at a 50 year low and nobody ever heard of it.
The pandemic brought another significant round of bond
buying. The Fed again took the safe Treasury bonds in
mortgage backed securities off the market.
They also set up lending facilities to buy bonds from
municipalities and corporations.
That was a new thing that the Fed did this time
around.
The 2020 bond purchasing program brought investors
flooding back into the stock market after a sudden
collapse.
Holding such a large balance sheet of nearly $9 trillion
has contributed to this infighting.
Where a lot of money is flowing into risk assets.
And you started to see some crazy things, things like
cryptocurrency or even nfts.
I think a lot of the fervor for those has been driven by
this ultra low rate environment, where the
pursuit for return meant going into to risk assets.
The large cash injections boosted large corporations
at the expense of smaller businesses.
The Fed just didn't have the right tools to really help
out small businesses.
And as we saw with the Main Street lending facility,
which was supposed to help out mid-sized businesses,
the Fed also didn't really have the right tools to
support them. By contrast, the largest companies in our
country are much more able to raise funds through
mechanisms like issuing debt into public markets.
And this has been bought up like crazy by these open and
bond funds and ETFs backed by bonds.
And what we don't want is the the complex set of
machines, that is, the financial systems to grind
to a halt because it lacks the liquidity.
You don't want to force a recession as a result of a
breakdown in the financial system.
Some members of the Federal Reserve contend that these
emergency asset purchases are necessary.
They believe that the debts will be paid as they.
Mature after almost every crisis.
There's often a survey, often a commission done or
hearing, etc., and then Congress decides how to
adjust the authorities to focus on these crises.
The resulting end of our pandemic asset purchases
will remove another source of unneeded economic
stimulus for the economy.
I expect that these steps will contribute to an easing
in inflation pressures in the coming months.
Certainly some of these people on the committee are
hot to begin reducing this balance sheet.
The Fed plans to unwind its asset portfolio at a more
aggressive pace than what it attempted following the
housing crash.
We may find for all of us that the price of money,
cost of the loan, the interest rate gradually
starts to rise from what has been historically very
low levels. I've already seen some of that.
Mortgage rates are a little bit higher now than they
have been in the past.
And also the borrowing rates for corporations are
somewhat higher.
The Fed will shrink its bond portfolio by 2 to $3
trillion in this round.
Market turbulence could follow the Fed's tightening
of the economy, sparking a recession.
Are we going to go back to the Fed having a balance
sheet of the size that it was in 2006 and early
2007? They are in far more skeptical.
The role of reserves on bank balance sheets has
changed a lot.
It's not fair to say the balance sheet is not
supposed to be used the way it's used.
It is a new tool.
What's new about it is one.
It's being used pretty consistently.
Two, it's being used at a scale that was not imagined
before. But it is very public.
But like lots of things in plain sight, you don't
necessarily notice it.
Prices for just about everything are rising fast.
In October 2021, inflation took its biggest jump in
more than 30 years.
It's hitting specific parts of the economy hardest.
Drivers face a 59% increase in the pump compared to one
year ago. The average used vehicle is selling for 26%
more than it was a year ago.
Vacation homes are renting out at a premium, too.
Nobody likes inflation.
Nobody wants to pay higher prices for anything, really.
Maintaining stable prices is one of the Federal Reserve's
main responsibilities.
In recent decades, the economy has hummed below the
central bank's target rate.
Now post pandemic.
The Fed may want inflation, at least for a while, to be
above 2%, and they'll get exactly what they want
simply because of the acceleration of rent growth.
Critics say there are signs of turmoil in the economy
the Fed isn't hearing.
I think it's pretty darn clear that the Fed cannot
control inflation on the downside or the upside.
Given the current experience.
The central bank has its defenders to.
The weight of the evidence is finally going pal's way.
Team Transitory is going to win.
There's a lot of reasons to think that inflation is
transitory. It doesn't mean it's going to be two months.
It could be a year, but it's not going to be four or
5% a year for the next five years.
In the backdrop, governments are spending big to keep
society afloat.
The US Treasuries debt is managed by the Fed.
The bank's assets swelled as it printed trillions of
dollars to backstop the country.
Which leads to the question can the Federal Reserve
control inflation?
And if so, what could it do to rein in the cost of
living in the United States?
The people who manage the US economy prefer to keep
inflation around 2%.
That's because a low and steady rate produces a
healthy business environment. These rates are
tracked in categories like food, energy and housing.
These components are then weighted against one another
to establish their importance. The final scores
that are produced are then recorded over time.
The primary one you hear about on the news is called
the Consumer Price Index.
It tracks all of the spending from 93% of the US
population. Then there's the trimmed mean inflation,
which throws out outlier data and focuses on core
prices. Movements in the trimmed mean signal a more
potent inflationary trend.
Then there's the.
Pce. The Fed really prefers to look at PCE.
That is, personal consumption expenditures.
Price Index.
The Fed's preferred measure of inflation is broader than
the trimmed mean, but it throws out some data from
the energy and food sectors. That's because
prices take bigger swings in these industries more
frequently. What's included in what's excluded from each
inflation index impacts its reliability.
Some, like Danielle DiMartino Booth, a former
Dallas Fed employee, believe that the PCE is
flawed.
My biggest issue with the PCE is that for your average
American household, you spend between 40 and 50% of
your income on housing.
If you look at it through that simple of a prism and
understand that the pieces input for housing is only
around 22%, then you see that you're undercounting
households biggest expense by a wide margin.
In the fall of 2021, the PCE numbers spiked to
generational highs.
When events like that happen, public officials
turn to the Fed for answers.
The Federal Reserve was originally set up to create
a stable American banking system.
Its role has expanded over its century long existence.
In 1977, Congress gave it a dual mandate.
Part of that mandate is to maximize employment.
The other part of that mandate is to stabilize
prices or to basically keep inflation in check.
Wilson says that the Fed's ability to manage inflation
depends on the extent to which inflation is driven by
the labor market.
We're currently seeing inflationary pressures
largely because people have shifted their consumption
from purchase of services to purchase of goods.
That has caused demand for goods to outpace the supply
of goods in a period of time that suppliers did not
have adequate time to really respond to that
increased demand.
In 2021, a sputtering global supply chain and backed up
ports are causing delays.
Many people, including the leaders of the Fed, don't
believe the economy has settled.
Chair Powell previously said This bout of inflation
is transitory, but now he's walking back from using that
language.
We tend to to to use it to mean that that it won't
leave a permanent mark in the form of higher
inflation. I think it's it's probably a good time to
retire that that word and try to explain more clearly
what we mean.
The central bank believes current conditions don't
change the long term outlook. That's because in
recent years, inflation has actually been lower than
what the Fed wanted.
Pre-pandemic, inflation was soft.
The Fed Reserve had a 2% inflation target.
It was below 2% now post pandemic.
The Fed has been saying they changed their thinking
here. They want inflation at least for a while to be
above 2%, and they'll get exactly what they want
simply because of the acceleration of rent growth.
In 2019, newly elected Chair Powell argued that long term
expectations of inflation were low.
Experts observing the labor market reported that the
interest rate lift off that began in 2019 cut the
recovery short. Then an unexpected event.
The pandemic pushed the central bank to create.
Accommodative financial.
Conditions. That means dropping interest rates,
which in theory will make prices rise more quickly.
Nobody likes inflation.
Nobody wants to pay higher prices for anything, really.
Economists believe that expectations are the primary
driver of inflation.
While people think inflation is going to be high for a
long time, they're going to say, Hey, Mr.
Employer, you've got to pay me a bigger you got to give
me a bigger pay increase because inflation is going
to be high. And the businessman says if he
thinks or she thinks inflation is going to be
high, let's say fine, no problem.
I'll give you a bigger pay increase, but then I'll pass
along the higher price increase to consumers.
And then, lo and behold, people's expectations, their
views of the future inflation actually results
in higher inflation.
That's the problem.
A wage raise means a corresponding rise in prices
unless productivity is increased proportionately.
What do you want? A guy with.
Forearms. But even people within the Fed think these
models are broken.
In September 2021, a senior economist at the Board of
Governors published a paper.
It was titled Why Do We Think That Inflation
Expectations Matter for Inflation?
That's definitely a non consensus view.
The paper argues that the field of mainstream
economics provides cover for a, quote, criminally
oppressive, unsustainable and unjust social order.
The paper reflects the views of a wider movement of
people who think the Fed needs reform.
There was an internal debate inside the Fed in 2008 and
2009 and 2010.
Why did we miss the financial crisis?
Why? We missed the subprime crisis.
And it was determined at the time that the Fed's
inflation model really was broken because had it
incorporated securities prices, had it improperly
incorporated that the price of housing, residential real
estate, then the Fed wouldn't have been
blindsided ahead of the financial crisis.
So what they did after writing all these internal
white papers and determining that they needed
a new inflation regime was nothing.
And because they needed this broken model to hide
behind, which systematically understates
inflation so that they could keep easier monetary
policy than they would otherwise to prop up the
stock market.
Many people who watch the Fed cite breakdowns in
models like the Phillips curve. The Phillips Curve is
a model that economists use to make interest rate
decisions. The model contains two inputs
inflation rates and employment data.
Various forces shift where the economy is along the
curve at any point.
When the employment indicators point to a tight
labor market. The plot of the Phillips curve shifts to
the left. That means that there are more jobs open
than there are workers to fill the roles.
That also increases the pressure on employers to
raise wages, which means higher rates of inflation.
The Fed can control inflation when it's coming
from the labor market.
Their main tool for doing that is the federal funds
rate. And by lowering that rate, it tends to help to
spur economic growth and job creation.
And when they raise that rate, it tends to slow that
growth and the resulting job creation.
The reason for doing that would be if there were
concerns about inflation growing too fast or
potentially getting out of control because the
unemployment rate is too low and starting to put
upward pressure on prices because there is upward
pressure on wages.
Some economists believe that in 2019 the official models
produced an error.
That year, unemployment dropped to 3.5%.
When unemployment gets this low.
The Phillips curve tells us that prices should start to
rise. The Fed started to hike interest rates before
sending them back down in the pandemic.
I think one of the things that we have learned coming
out of that recession and more recently is that
the economy has probably been
further from what would be a genuine level of full
employment.
Some say that the failure to lift off interest rates is a
mistake that the country will have to pay for in the
future.
Jay Powell in 2018, 2019 found out that he couldn't
raise interest rates, so he failed to get interest rates
to his his own personal stated target of 3%.
He never got to.
When you have a Federal Reserve that one cycle after
another, they try to resolve an underlying issue
of overindebtedness, whether it was the household
sector before the financial crisis or the corporate
sector before COVID hit.
Every time they have a crisis hit, they try and
solve the problem of overindebtedness by putting
more debt into the economy.
Others still believe that the country is in an
extraordinary time that calls for emergency
measures.
The current environment that we find ourselves in is
extremely unusual.
All of that really is affecting inflation in a way
that we wouldn't typically see during the normal course
of how the economy functions.
In recent decades, outside forces changed labor in
fundamental ways.
When unions were a force to be reckoned with and when
employees had the upper hand.
Then there was a very tight relationship between
inflation and wage inflation, so you could have
this spiral of rising wages.
When we started to dehumanize the country, when
employers started to outsource to India and other
countries and started exporting deflation because
its labor was so much cheaper.
All of these elements ended up giving employers
the upper hand over employees in America.
So the efficacy of the Phillips curve started to
become kind of outmoded, and there wasn't this
immediate feedback effect from rising prices into
rising wages.
Policy decisions informed by models like the Phillips
curve have had a real impact on American workers.
The wages and benefits of a typical worker were
suppressed in the period for decades after 1979.
Why is that? Well, it's not because the economy was
doing poorly or because of automation or because of low
productivity growth.
In fact, it was because of policies which generated a
situation where wages were suppressed.
Excessive unemployment because of.
Failed macroeconomic policy.
Monetary and fiscal policy to the bashing of unions.
The decline in union membership.
The failure to increase the minimum wage along with
inflation. Various new policies of corporations
forcing people to sign non-compete and forced
arbitration agreements.
As a result, leaders are making adjustments to
prepare for the new normal.
Longer term inflation expectations, which we have
long seen as an important driver of actual inflation
and global disinflationary pressures, may have been
holding down inflation more than was generally
anticipated.
President Biden nominated Powell for a second term,
hoping that would help the Fed maintain its
independence.
I'm nominating Jerome.
Powell. That'll be important as the group embarks on a
new and unusual decade.
So I think the strategy the Fed is now pursuing is the
stated. Stated strategy is to try to keep the job
market really tight, really strong for an extended
period. And that means then you'll see stronger wage
gains across all income groups, but particularly low
wage firms. But it's you know, it's a tricky thing
and very difficult to pull off.
The Fed has kept interest rates near zero for more
than a decade, and the outlook suggests that it
will keep rates low for the foreseeable future.
That's because the United States and countries around
the world have failed to hit their inflation targets
in recent years.
The Fed itself was incapable before of creating
inflation. It was, quote unquote, pushing on a
string. So it said, you know, we're going to allow
inflation to run hot going forward so that we can try
and and balance out all of these years of not being
able to produce the inflation that we said we
wanted to target, being underneath that 2% target
for so many years.
In other words, if the temporary bottlenecks caused
by the pandemic and its supply chain disruptions
fade, we'll need to keep interest rates low to keep
the economy afloat.
Some say the Fed may be better off pursuing a higher
long term inflation target, possibly of 3%, that can
fight the expectations of sluggish future growth.
I think the deflationary forces will continue to be a
force, especially up the income ladder.
Now that you can put an entire law library into a
little chip of big data, you don't need a paralegal
in the United States. You can get a paralegal in
India. So higher income paying jobs right now are
the ones that are at at risk of being sent over
shores, and nobody's talking about that.
You're actually going to have inflation in terms of
the amount of education you need in America.
You're going to need that graduate degree to have the
pure certainty of income security going forward,
because you're going to need that next skills level
up because a lot of jobs that require a bachelor's
degree are going to go away.
So that disinflationary impulse is going to be
there.
But in the short term, the Fed and the entire country
will wait to see if these price spikes come.
There's no obvious direct way the Fed can help.
Really. The onus, I think, is on Congress and
administration. Lawmakers do have the tools, the
ability.
I don't think that the American rescue plan created
this crisis or that the Fed's monetary policy has
created the inflation problem.
Their ability to change the interest
rate would do something.
It would slow the pace of the recovery.
Central banks around the world have injected money
into the economy at a record pace to try to fight
a global recession triggered by the coronavirus
pandemic.
Just getting word from the Federal Reserve, a.
Bombshell announcement from the Federal Reserve.
It is an absolutely historic week, both in terms
of the speed of Fed purchases and, of course,
the magnitude.
Since mid-March, the Federal Reserve's balance sheet has
ballooned from $4 trillion to around $7 trillion, equal
to about one third of the value of the entire American
economy.
The new CNBC survey showing that market participants
expecting trillions more in stimulus from both the
central bank and Congress.
At the same time, governments have enacted
record amounts of fiscal stimulus to boost economies
stalled by the pandemic.
The infusion of cash into the financial system has
renewed concerns that inflation could surge.
As Milton Friedman said, inflation is always in
everywhere a monetary phenomenon.
If you believe that.
You look at the central bank balance sheets
exploding right now and you say there's going to be
inflation.
Supply shocks have driven up prices for some goods over
the past few months.
Yet recent history suggests inflation is more likely to
stay low for a long time, as unemployment remains near
record high levels and consumer spending is
subdued.
While there certainly is quite a lot of disruption to
the supply side of the economy, that's likely to be
dominated by the huge hit to aggregate demand.
So how will trillions of dollars of economic stimulus
affect the outlook for inflation?
Inflation refers to an increase in the prices of
goods or services over time.
One well-known measure of inflation in the US is
called the Consumer Price Index, or CPI.
The CPI is about the prices that we pay for
services and goods and housing and rent.
Economists say some inflation is healthy for the
economy. When the economy is growing, more consumers
and businesses are out spending money on goods and
services. This increase in demand results in higher
prices. Demand is an important factor in the
outlook for inflation.
Generally, when unemployment is high and
consumer demand is weak, inflation is low.
Another factor that affects inflation is commodity
prices. If oil prices rise because there is a cut in
production, gas prices might increase, too.
Consumer and business expectations about prices
are another piece of the inflation puzzle.
If a lot of people expect prices will rise in the
future, they might spend more now, ultimately causing
inflation.
The level of actual inflation that we get will
be pretty heavily influenced by the inflation
rate that actors in the economies of households,
businesses, consumers, workers, investors expect to
prevail.
Like many other central banks around the world, the
Fed targets a 2% yearly inflation rate.
At that rate, a cup of coffee that costs $2 this
year would cost $2.04 next year.
Not quite enough to break the bank.
Central banks adjust their policies normally by
changing interest rates to try to get to that 2%
inflation level.
You definitely want to keep enough inflation so you can
still have enough space to raise and lower Fed funds
over the business cycle.
Too much inflation isn't a good thing either.
As inflation rises, the money that you hold today
becomes less valuable tomorrow at a 15% inflation
rate. For example, your $2 cup of coffee today costs
$2.30 next year.
Think of how that would affect a bigger purchase
like a car. A $10,000 purchase today would cost
$11,500 next year.
When the inflation rate is very high.
It's very difficult to make any calculation about
saving.
Inflation concerns for now.
Or to the downside, the risks are to the downside,
not to the upside.
We see prices moving down, and that's because in a lot
of parts of the economy, people are cutting prices.
Lockdowns have already depressed prices in the US
as consumers stay at home and remain cautious about
spending money in an uncertain economy.
The second biggest drop in headline inflation since
1947 energy commodities down 20%, with a 20% decline
in gasoline. Fuel oil down 15%.
There have been pockets of inflation in some areas,
like groceries, as more people cook at home.
Disruptions in global trade from the virus have also
raised prices for goods like medical supplies.
Still, these supply shocks haven't offset overall weak
demand.
If you're in the average person's seat, we're talking
about grocery stores and that sort of thing.
The idea that there's going to be an outbreak of
inflation, 4%, 5%, that is just not on the horizon.
Many economists and policymakers expect wages
will stay low as unemployment remains high.
Meanwhile, people are saving instead of spending
their cash out of fear, the economy could get worse.
To try to boost the economy. Policymakers in
Washington have pumped trillions of dollars into
the financial system in recent months.
Economic theory suggests all this money printing
could create the risk of inflation.
Economist Milton Friedman famously said that if
there's too much money in the economy chasing too few
goods, prices will rise.
When inflation was surging in the 1980s, Fed Chairman
Paul Volcker put Friedman's theory to the test.
And it worked. Volcker slowed the growth of money
going into the economy and raised interest rates to
tame inflation.
But economists say there's been a break in the link
between money creation and inflation in recent years,
as the banking system has become more complex.
The rise of the financial system and sort of the
diversification of the financial system is one of
the reasons why sort of the Milton Friedman view of the
world really is not as applicable, particularly in
the United States as it was in an earlier time.
It's important to understand that when the central bank
prints money today, most of it isn't in the form of
physical dollar bills.
Instead, the Fed creates electronic money.
It uses that electronic cash to buy assets and lend
to banks injecting money into the banking system to
buy treasuries. For example, the Fed uses
so-called primary dealers, a group of around two dozen
big banks and brokerage firms that trade bonds.
What happens when the Fed creates money?
Is it strictly it creates central bank money or
reserves. Those are held by the banking system.
Now the banks decide what they're willing to lend out
into the economy.
That means that even if the Fed is pumping a lot of
money into banks like it is today, the money won't reach
the hands of consumers until banks lend it out.
It is true that money has been handed out directly to
citizens as part of the federal government's
coronavirus response, like the 1200 dollars stimulus
checks. This cash infusion still might not result in
inflation. Most Americans needed the checks to make
day to day payments to make up for lost income during
the crisis, not to go out and spend lavishly on other
purchases.
I think of them as more life preservers, trying to
prevent the economy from getting into a deeper hole
because of the COVID crisis. And they don't
represent stimulus yet.
Recent history suggests that all the fiscal and monetary
stimulus during the pandemic is unlikely to
increase prices for consumers.
When the Fed bought trillions of dollars of
assets after the 2008 financial crisis.
Inflation never surged.
After the Great Recession, there was a conviction that
all the fiscal and monetary stimuli were going to result
in huge inflation.
As a matter of fact, a number of investors,
including some very famous hedge funds, went to gold.
Well, what happened?
Big deficits, but inflation has come down.
The experience of the last decade is that central bank
balance sheet expansion certainly need not generate
a period of excess inflation.
And in fact, even with a big balance sheet, might
still be hard to get the inflation that you want.
There are limits to what history can teach us when it
comes to understanding the economic situation right
now. Even if the economic stimulus doesn't result in
higher prices for consumers, many say that
inflation is showing up in the prices of other assets
like the stock market or the housing market.
One of the most interesting questions that we have right
now is the difference between the price inflation
that you and I see at the grocery store or the gas
pump or when we're buying something.
That's one measure of inflation.
But another measure of inflation that is also very
important is asset price inflation.
In other words, what's happening to the stock
market and what's happening to, you know, credit
spreads? I think we're looking at very significant
increases in asset price inflation.
Inflation expectations are another risk.
If people start thinking, oh, the money supply is
increasing, inflation is going to be higher than
expected, inflation becomes high.
Then you start asking for hot increases in wages and
prices. And the these expectations become what we
call.
Self-fulfilling.
In the long term. Factors like globalization,
technology and aging populations all play a role
in consumer prices.
A weaker US dollar or backlash against global
supply chains which have been disrupted during the
pandemic, could create inflation risks.
If you were to seal the borders and literally cut
off any imports and then embark on this huge monetary
and fiscal stimulus, yeah, they could they could create
inflation.
There's one more big risk to inflation, and it comes with
nine zeros attached record high public debt.
Trillions of dollars in economic stimulus during the
pandemic have increased government debt at a rapid
pace. In recent years, some economists have argued in
favor of deficit spending to fund public investment,
though many debate what effect this could have on
inflation because government debts are set in
fixed dollar amounts, higher inflation makes it
easier to pay off those debts.
Some worry that politicians might put pressure on
central banks to chase higher inflation to help
finance the growing national debt.
We need not worry too much about the size of the Fed's
balance sheet. What we need to be focused on is whether
the Fed will, at the appropriate moment, have
both the judgment and the institutional independence
to raise interest rates, even if that might conflict
with some other interests, for instance, the interest
of the government of the day.
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