Areté quarterly review Q121: Incorporating inflation

Several positive developments over the last several months have dramatically improved the near-term outlook for the economy. Accelerating vaccine rollouts, increasing business activity, continued easy monetary policy and huge new doses of fiscal spending are all contributing to the potential for higher economic output. All these factors, however, are also increasing concerns about inflation, and rightly so.

The good news is there is plenty of commentary that provides useful updates and insights for investors to monitor the situation. The less good news is there is no easy answer to the debate between inflation and deflation/disinflation. A significant challenge, then, is figuring out how to incorporate an uncertain path for inflation into an investment strategy.


One of the interesting characteristics of commentary about inflation (or most investment topics for that matter) is the one-sided nature of arguments. Most commentary makes a pitch, for or against, and rattles off as much supporting evidence as possible.

This tendency is exacerbated by another interesting phenomenon:
There seems to be something of a competition to produce the cleverest insight. This is understandable to a large degree since authors are keen to build their reputations on the basis of insights that prove to be right. However, the very notion that there even exists a "right" answer from which attentive investors might reap a windfall belies the grinding uncertainty of an issue like inflation.


These characteristics can be observed in the arguments for inflation. Arguably the most common argument for inflation is massively increasing money supply. It doesn't take much of an economist to look at a chart of money supply or central bank balance sheets to wonder how long existing trends can be sustained.

There are different permutations on this theme. One view relies to some degree on faith that huge piles of money will eventually find their way into the economy but is agnostic as to how that happens. Another view is that governments will increasingly get involved in the lending process (by backstopping loans, for example) which will significantly ramp up the speed of the money creation process.
Both are supported by a longer-term historical perspective that points to inflation as the preferred manner by which to manage excessive levels of sovereign debt.