The Fed’s great monetary policy experiment is being pushed into new frontiers, but may more likely create more inflation in asset prices than the real economy.
Monetary policy was already heading into uncharted territory before the pandemic—but Covid-19 has sent it into overdrive. The current round of quantitative easing (QE) is theoretically unlimited, fulfilling the “QE Infinity” moniker. Since March, the Fed has often purchased more assets in mere weeks than it did for entire past QE programs (Federal Reserve, October 2020).
With the Fed additionally dipping its toe into credit and high yield assets for the first time (as well as the usual Treasury and Mortgage Back Securities (MBS) purchases), it may even be more accurately referred to as “QE infinity and beyond.”
Lower For Ever Longer
The Fed has additionally forecast that it will keep rates at the “zero bound” for multiple years as it implements its new policy targeting an “average” rather than an absolute inflation level of 2%.
This implies that it will let inflation run “slightly hot” before turning down the stimulus tap and reversing any of its current easing policies.
On the flip side, if financial conditions take a turn for the worse, the Fed has made clear that it will up its asset purchases from the current monthly run-rate of at least $40bn in mortgage-backed securities (MBS) and $80bn in Treasuries.
The bottom line is that financial assets live in a world in which Fed’s current actions are bigger, broader and faster than they’ve ever been.
Inflation Still Missing For Now
Considering this unlimited ammunition, and a Fed willing to tolerate a temporary inflation overshoot, should this have us worrying about the inflation genie finally bursting out of the bottle?
We don’t think so. Monetary policy has already pushed against its limits in Europe and Japan but still failed to generate any meaningful inflation. Monetary policy both at home and abroad has only really stimulated inflation in asset prices, and that will potentially continue to be the case.
The greater risk of inflation will likely come from fiscal policy stimulus. As monetary policy approaches the limits of its efficacy, Fed Chair Powell himself has been one of the many voices calling for the Treasury to step in to keep stimulus flowing to support the economy, above and beyond the Covid relief bills.
This has been part of a wider sea change in the economic system. We are potentially shifting from the post-1970s central bank-dominated “neoliberal consensus” to what we are tentatively calling “neofiscalism.” It casts the role of QE as more of a vehicle for financing (or “monetizing” to use the correct economic phrase) the Treasury’s debt issuance in a manner that can keep a lid on yields.
But at best, this only implies that inflation, if anything, is a long-term concern (perhaps several years away) and not a near-term phenomenon.