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11.12.20  |  Investment Management

2020 Outlook Theme #3: Will Helicopter Money Rescue the Economy, or Cause Inflation to Take Off?

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The primary policy side effect would be inflation. As noted on 3/31/20: While short term support for the economy and developments on the healthcare policy front are the main focus right now, the longer term question is whether the $6.7 trillion stimulus will be inflationary and what the long term impact on the Federal debt will be.

In 2008, the concept of the Federal Reserve buying bonds to keep long term rates down, known as QE, was a largely untested theory put into practice to support the economy. The next step out the theoretical ladder is known as “Helicopter Money”, referring to the Fed printing money and figuratively dropping it from helicopters on the economy to spur economic activity and/or inflation should simple QE not work. From a practical standpoint, a rapid ramp in fiscal stimulus including direct payments to individuals paired with the Fed leveraging itself up to buy bonds directly from businesses looks a lot like helicopter money. How it will ultimately end up depends on the nature of the programs: how large they are versus the economic shortfall and whether the programs are permanent or temporary.

On the fiscal front, Treasury spending is now up to nearly $2 trillion (from $1.6 trillion), while loans are around $774 billion. Assuming the economic disruption is relatively temporary, and thus the surge in fiscal stimulus does not prove to be recurring, this spending serves to offset the lost economic activity. By filling in this lost demand, it prevents DEFLATIONARY forces from taking hold.

For monetary policy, much of the Fed’s $3.8 trillion is also not permanent, and thus has far less inflation impact than the very large headline amount suggests. In fact, the SMCFF/PMCFF’s mere existence supported the credit markets, even before they were deployed. So not only can Fed programs be pulled back, but they may not even reach close to their stated maximum capacity. This is good as it delivers a benefit with even less long term distortion.

For now, the conclusion remains: Overall, yes, adding $6.7 trillion stimulus (about 30% of $20 trillion GDP) would be inflationary if the economy was at or near capacity. But if a large portion of that stimulus is temporary and so goes away when no longer needed, and the remaining portion offsets deflationary lost spending, then the inflation impact is less than it might appear.

There is, however, an inflation consideration beyond the crisis response. During Q3, the Fed made a notable shift to its “policy framework”, meaning the how data is considered when setting interest rates. Traditionally, the Federal Reserve has balanced readings on inflation and unemployment, based on the idea that low unemployment will eventually spur inflation, and so when unemployment would get low, the Fed would start to raise rates (or otherwise tighten policy, such as slowing QE). Over the past 10 years, however, inflation has remained at or below the Fed’s 2% target. This has raised the question as to whether the Fed has been too quick to raise rates and has prevented unemployment from truly getting low enough.

Consequently, it has changed its framework from anticipating that unemployment is getting too low, to one of “don’t fire until you see the whites of their eyes,” meaning they will wait until inflation really is lifting off before raising rates. Also, the Fed emphasized it wants inflation to average 2%, not have a 2% ceiling, so inflation of 2.5% is tolerable. With unemployment at 8.4%, the Fed is a good distance away from the 3.5 – 4% range when this policy would actually have an impact on its actions. It might mean, for example, the Fed would think about raising rates in late 2023 instead of late 2022. This will be relevant when that time (and sub 4% unemployment) comes, but for policy actions right now, the impact is minimal.

The Fed has clearly shifted its focus to supporting the economy until the point that inflation is generated. The hope is that this results in unemployment being pushed down to a new, lower, level than was previously thought. The issue is, whether its good inflation or not, that bond yields have reached historic lows thanks to the 20 year drop in inflation. Any form of higher inflation, therefore, could cause this interest rate backdrop to shift. With the 10yr Treasury at just 0.68%, the Fed committing to getting inflation over 2% should raise some concern. Thus it is important to wonder Will Helicopter Money Rescue the Economy or Cause Inflation to Take Off?

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