In Unprecedented Times, Don’t Rely on (Obvious) Precedent

In 1974, U.S. President Gerald Ford took office “amidst one of the worst economic crises in U.S. history,” which was characterized by double digit inflation. Shortly thereafter, the new administration and Congress established the National Commission on Inflation, and the President declared inflation to be “public enemy number one.” He urged Americans to voluntarily increase personal savings and discipline their spending habits, with a goal of harnessing untethered price increases. “People who supported the mandatory and voluntary measures were encouraged to wear “WIN” (Whip Inflation Now) buttons, perhaps in hope of evoking in peacetime the kind of solidarity and voluntarism symbolized by the V-campaign during World War II.” Ultimately, the campaign to “whip inflation now” was an abject policy failure and years of economic and financial market volatility followed (Source: Wikipedia, as of March 31, 2021).

Photo: A WIN button from the 1974 campaign
Source: Wikipedia, as of March 31, 2021

Policy Largess At a Time of Economic Tailwinds

Today, the Federal Reserve (Fed) is flirting with a mirror-image of that policy, by steadfastly adhering to its new average inflation targeting (AIT) ideology, which aims to thwart powerful secular disinflationary influences that have kept inflation stubbornly low for the last decade. Specifically, the Fed has promised to stay extraordinarily accommodative until economy-wide levels of inflation exceed their long run inflation targets for an extended period of time. And that policy would seemingly be pursued without regard to some very real left-tail risks around financial stability and possible unintended consequences. Thus, investors face a growing amount of uncertainty as a result.

Visibility is being clouded significantly further by surging fiscal stimulus amidst the rapid reemergence of the U.S. economy from the 2020 pandemic shock. Indeed, the combination of extreme central bank accommodation, combined with profound and historic deficit-financed fiscal policy is creating the most powerful economic policy cocktail in the history of peacetime America. This is occurring at a moment when the U.S. economy appears to already be functioning very near its potential. The federal government is pumping trillions of dollars of broad money liquidity into an economy that’s already flush with cash. The 2021 federal deficit Is now forecast to equal 15% of GDP, matching 2020’s record shattering deficit, and with the help of the central bank’s monetization of these deficits, U.S. broad money will continue to grow at an outsized clip. We estimate that by the end of this year, nearly a third of all broad money in circulation in the United States will have been created over a 20-month interval from the onset of the pandemic.

This policy largess comes at a time where the U.S. economy already enjoys the tailwinds of robust consumption, booming manufacturing and a red-hot housing market. It also comes at a time when household balance sheets are surprisingly strong, thanks to broadly distributed federal stimulus initiatives (for example, household debt service levels are near the lowest point they have ever been). And while some lagging services segments have been slow to rebound, it is highly likely that a recovery is close at hand with vaccine rollouts accelerating in earnest, catalyzing mobility, engagement and general economic reopening. This recovery will be further supported over coming quarters by the incremental spending associated with President Biden’s Build Back Better plan, and its bold endeavor to upgrade U.S. infrastructure and make broad-based societal investments.