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. 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.
