The Consumer Price Index (CPI) data released yesterday showed that inflation in the United States fails to materialize. Despite huge M2 money supply growth, monetary and fiscal easing, inflation is nowhere to be found.
In fact, the core data, the one that excludes energy prices, was less than 0.1% in December. If anything, the Fed should worry about the lack of inflation rather than anything else.
By changing its mandate in the summer of last year, the Fed signaled that it is ready to let inflation overshoot the target. More precisely, to let it fly above 2% for a while. Yet, inflation threatens to break below zero. Traders familiar with the Bank of Japan’s situation cannot stop making a comparison between them too. The Bank of Japan did something similar in the past, without much success in bringing inflation higher.
Why Does Inflation Remain So Low?
The short answer is that the money is not put to spend where it should be. The coronavirus pandemic brought massive monetary and fiscal support for the U.S. economy. Prior to the health crisis, only the mention of the so-called “helicopter money” was enough to generate intense discussions on the financial community on the rampant inflation it will generate. What those discussions failed to consider was the use of money.
Let’s put it in simple words. Uncertainty is still on the rise, and jobs continue to be lost, as seen by the December NFP data (e.g., 140k jobs were lost by the U.S. economy in December 2020). Therefore, most of the money received by households goes into savings, credit card debt, and (strange enough) investing.
The new money will translate into higher prices only if it is deployed in the real economy. Without it happening, inflation will remain subdued. At this point, the problem is not that it is not enough money around, but that the money is not put to good use.
Democrats promised further fiscal stimulus. However, this will risk pushing stock prices even higher, and the savings rate as well. Perhaps a better way of stimulating the economy is to find a way for households to use the money received in the first place.
Naturally, this does not apply to all households. Many families are in dire need of food and money for survival. Yet, studies show that a big chunk of the checks received so far went straight into the stock market and not in the real economy. We should not expect higher inflation as long as this continues.