At the recent Jackson Hole Economic Summit, Jerome Powell unveiled the Fed’s new monetary policy designed to create inflation. In today’s #Macroview, we will discuss the 5-reasons why the Fed will not get inflation, and why deflation is the bigger risk.

The current assumption is that the Fed’s new policy will lead to higher inflation.

“The new policy regime is an important evolution in our thinking about how to achieve our goals and another step toward greater transparency, The policy change positions us for success in achieving our maximum employment and price stability goals in the future.” – Fed Reserve Bank of NY, John Williams, via WSJ

What exactly is this new policy? Well, that’s the interesting part, no one actually knows. However, as noted by the WSJ:

“The Fed said it would now seek to hit its 2% inflation target on average, and that it wouldn’t raise rates just to ward off the theoretical threat of inflation posed by a strong job market. The Fed, however, didn’t say how it would determine the average, and several regional Fed officials suggested that a 2.5% jobless rate was as much as they would tolerate. At the same time, with the economy in deep trouble, there is little expectation inflation will test the Fed’s target for years.”

So, to be clear, the Fed’s new policy is simply to “average the inflation rate” over a period of time and let the unemployment rate fall to as low as 2.5%. The last time the unemployment rate was at 2.5% was for one quarter in 1953 just before the 1954 recession set in.

Fed's New Policy Inflation, #MacroView: 5-Reasons The Fed’s New Policy Won’t Get Inflation

 

40-Years Of Falling Inflation

The entire premise behind the Fed’s “new policy,” and by being extremely vague about it, is to allow the Fed to maintain, and engage in, “ultra-accommodative” policies without any real limits. However, as shown below, the Fed’s monetary policies have not been successful at creating stronger economic growth or inflationary pressures.

Fed's New Policy Inflation, #MacroView: 5-Reasons The Fed’s New Policy Won’t Get Inflation

Furthermore, while Wall Street is “buzzing” with talk of surging inflation, the reality is such is not likely to be the case. As we discuss below, the Fed’s policies are actually “deflationary” in nature.


Why Printing Money Won’t Create Inflation

“The Fed is printing money like crazy which is going to lead to inflation.”

For the last 12-years, this belief has remained a constant in the market. It stems from the idea that increasing the money supply is inflationary as it decreases the value of the dollar. There is indeed truth in that statement when considered in isolation. However, when the money supply is increasing, without an increase in economic activity, it becomes deflationary.

The chart below compares the money supply to GDP growth and our composite economic indicator which is comprised of inflation, wages, and interest rates which all have a direct correlation to economic activity.

Fed's New Policy Inflation, #MacroView: 5-Reasons The Fed’s New Policy Won’t Get Inflation

Importantly, since 1980 as the money supply increased, economic activity slowed.

This is where monetary velocity becomes important.