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  • 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. Bombshell announcement from the Federal

  • Reserve. It is an absolutely historic week both

  • in the 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 dollars to

  • around 7 trillion dollars, equal to about one

  • third of the value of the entire American

  • economy. A 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 and

  • 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 this 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 U.S.

  • 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's 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's 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,

  • households, businesses, consumers, workers,

  • investors expect to prevail.

  • Like many other central banks around the world,

  • the Fed targets a 2 percent yearly inflation

  • rate. At that rate, a cup of coffee that costs 2

  • dollars this year would cost 2 dollars and 4

  • cents 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 percent 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 side.

  • 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 percent inflation rate, for example, your 2

  • dollar cup of coffee today costs 2 dollars and 30

  • cents next year.

  • Think of how that would affect a bigger purchase

  • like a car. A ten thousand dollar purchase today

  • would cost eleven thousand five hundred dollars

  • next year. When the inflation rate is very

  • high, it is very difficult to make any calculation

  • about saving.

  • Inflation concerns for now are to the downside.

  • The risks are to the downside, not to the upside.

  • We see prices moving down.

  • That's because in a lot of parts of the economy,

  • people are cutting prices.

  • Lockdown's have already depressed prices in the US

  • as consumers stay home and remain cautious about

  • spending money in an uncertain economy.

  • The second biggest drop in headline inflation

  • since 1947.

  • Energy commodities down 20 percent, with a 20

  • percent decline in gasoline.

  • Fuel oil down 15 percent.

  • 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, you know, grocery stores and that

  • sort of thing. The idea that there's going to be

  • an outbreak of inflation, you know, 4 percent, 5

  • percent, 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 the 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? It strictly creates central bank reserves.

  • Those are held by the banking system.

  • The banks decide, you know what 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 1,200 dollar stimulus checks.

  • This cash infusion still may 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 Kovik

  • crisis. And they don't represent stimulus yet.

  • Recent history suggests that all the fiscal and

  • monetary stimulus daring 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 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 to 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 at 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 credit spreads?

  • I think we're looking at a very significant

  • increases in asset price inflation.

  • Inflation expectations are another risk.

  • People start thinking all of the money supply is

  • increasing. Inflation is going to be higher.

  • Then expected inflation becomes high.

  • Then you start asking for increases in wages and

  • prices. And 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 U.S. dollar or a 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 stimuli, 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 today.

Central banks around the world have injected money

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Why Printing Trillions of Dollars May Not Cause Inflation

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    day posted on 2020/07/29