While massive monetary policy response didn’t drive inflation following the 2008/09 financial crisis, institutional investors are mulling over whether things may be different this time.
The global economy has rarely seen such a swift willingness to engage with economic calamity on both monetary and fiscal levels, says Erik Weisman, chief economist and fixed income portfolio manager at MFS Investment Management.
These actions don’t guarantee inflation — the natural enemy of retirees — but it’s easy to see how the economy could start down a path in its direction, he says. “It’s really about whether we think the market is pricing in the possibility of inflation as much as it should. And I think the answer, at the moment, is it isn’t.”
Notably, actions on the parts of governments and central banks have a very different purpose during the current crisis. Specifically, governments are focused on stabilizing conditions for the average household and business, rather than propping up flailing financial markets.
Fiscal policy changes are the real game changer today, says Weisman. “We did monetary last time. We broke all the rules. We did quantitative easing, we bought things we didn’t think central banks were supposed to buy and we’re doing more of that this time. We’ve broken very little new ground on the monetary side.”
Actions like Australia’s implementation of yield-curve control, following in Japan’s footsteps, aren’t especially ground breaking, he says, noting they simply go further along the path laid by the great financial crisis.
“What would really be a big change would be moving in the direction of modern monetary theory, which is, as people say, neither monetary because it’s fiscal, nor a theory. Be that as it may, we have policy-makers . . . who are of the opinion that you can run very large fiscal deficits for a long time, as long as interest rates remain low and you have a pretty significant negative output gap. That, I think, would change things.
“Some people would already argue that we’re implementing modern monetary theory now. And I think you can only really say it in hindsight since you need to see sustainable, durable fiscal deficits, where there’s very little attempt to bring the budget back to balance. And we won’t know that for years.”
Whether or not inflation is occurring is similarly difficult to observe in real time, he says. Money’s velocity — the frequency with which it changes hands in a given period — is worth watching, but it’s tied to a country’s gross domestic product, which is reported monthly at most.
The velocity of money has been on the decline for decades, says Weisman, noting the pandemic caused it to fall precipitously as households and businesses clung to any reserves of cash they had. As governments pumped subsidies out, some money started to flow back out into the market, but much of it went into savings, where it sits waiting to be released at some unknown later date.
“We look at Canada, the U.S., Australia, Japan, the Eurozone — these measures of savings rates have skyrocketed. If we see that savings is declining and velocity is rising, that means money is getting into the system. And that would suggest, at least in the short term, that you’re likely to have higher price levels than you might have otherwise. Whether that’s sustainable and durable is going to remain an open question.”