On June 23, GLG held a Remote Roundtable for select clients with Dr. Anthony Chan, former Chief Economist at JPMorgan Chase. During the event, entitled “Inflation Metrics and Indicators — Impact of Modern Monetary Theory,” Dr. Chan discussed the key metrics around short- and long-term inflation, the role of international pricing today versus the 1970s, and what current U.S. wage trends mean to the economy, as well as answered questions from attendees. Before the event, we were able to ask Dr. Chan five questions about the current economic environment, from the potential for inflation to the influence of the central bank.

As we think about the current economic environment, the dramatic increase in the money supply, and the potential for inflation, what’s your near-term outlook for our economy?

The U.S. economy is benefiting from a very expansionary monetary policy. The official M2 money supply is up 32% from February 2020 — just before COVID-19 was declared a global pandemic — through the latest data (May 25, 2021). The assets on the Federal Reserve balance sheet accumulated over this period adding liquidity to the U.S. economy, colloquially known as quantitative easing (QE), nearly doubled from February 2020 to June 17, 2021, rising from $4.1 trillion to $8.1 trillion.

On the fiscal front, the U.S. economy has spent approximately $5 trillion on COVID-19 stimulus programs (adding the $3 trillion spent under President Trump to the approximately $2 trillion under President Biden).

Given these factors, along with the reopening of the U.S. economy that is in progress, the U.S. economy is likely to grow by approximately 7% during 2021 and 3.5% in 2022.

We’ve heard that the inflation we’re currently seeing is transitory. What makes it transitory and how accurate do you think this assessment is?

The acceleration in inflation that we have experienced in 2021 as the CPI has risen to a 5% year-over-year rate should not come as a surprise once we factor in recent developments.  Those include a quick reopening of the economy, supply-side disruptions, more job openings than workers willing to work at the moment due to child care challenges, lingering concerns about returning to work due to the pandemic, and generous unemployment insurances benefits that had made it more profitable to collect these government payments while delaying a return to work.

As a result, I strongly believe that some of the current inflation pressures are structural while others are transitory. Many of the higher wages are being paid via one-time bonus payments. Those increased payments are nonrecurring and will therefore be transitory.

However, many of the price pressures developed by supply-side bottlenecks are likely to ease. Lumber prices are already down more than 50% from their peak. Half of the U.S. states have eliminated the enhanced unemployment benefits that have made it more profitable to delay returning to work while the other half will see the program end during the week of Sept. 6, 2021.

Stated another way, some price pressures are structural while some are transitory. Still, I believe that the core personal consumption expenditures price index is likely to rise by more than the 3% yearly rise projected by the Federal Reserve during 2021 but likely to fall below 3% during the 2022 calendar year and move closer to the 2% inflation rate targeted by the Federal Reserve.

It is important to note that the Federal Reserve has been targeting this inflation metric at 2% since January 2012 but for the most part has come in below this growth target from that date to the present. As a result, they have some flexibility to allow the inflation rate to run slightly higher than their current price target and still be able to meet such targets over longer periods.

Is stagflation a current or imminent concern?

 With growing inflation pressures and the fact that in 2022, the U.S. economy will experience a $1.5 to $1.8 trillion fiscal drag as the current pace of stimulus disappears, the risk of stagflation cannot be ignored. Some may ask, what if the current infrastructure bill is passed for $1 trillion to $1.5 trillion? Those payments will be disbursed over the next five to eight years, which means that only a small fraction will be spent each year. So, with an outsized fiscal drag for 2022, a large part of the current inflation pressure may become structural rather than transitory. If this scenario comes true, the risk of stagflation becomes nontrivial. It is not my base case, but it remains a nonzero probability outcome.

Can you talk through central bank influence when it comes to setting long-term rates?

 My doctoral dissertation focused on the yield curve, so this is my favorite question. Traditionally, controlling short-term rates is much easier for a central bank than controlling long-term rates. That is the case because long-term rates are determined by inflation expectations and a so-called term premium that measures how much investors need to be compensated for lending out money over a longer period. Finally, we need to add an uncertainty or risk premium to this rate too.

Nonetheless, some central banks like the Bank of Japan have pursued yield curve control strategies that target long-term rates within a range and simply buy and sell a particular government security maturity (via open market operations) to keep the rate within the specified targeted range. It can be done even though it is more challenging than simply trying to control short-term rates.

Are there any historical examples comparable to today’s environment that we can learn from?

 Many investors often seek to compare the 1970s inflation period to the current period to see if there are strong parallels present to allow us to assume that history will repeat itself. However, the parallels between both periods are not very strong. During the 1970s, the year-over-year rise in food prices exceeded 16% while food prices are rising at a 2% growth pace today. And currently, we are seeing corn and wheat prices easing instead of rising from recent readings.

On the energy front, we observed the global price of a barrel of oil rise from less than $4 to a peak of $40. At present, oil prices are rising 56% on a year-over-year basis but remain lower than they were during October 2018. There is little chance of seeing oil prices rise by a factor of 10 as they did between 1970 and 1980.

Finally, consumer surveys — such as the University of Michigan’s Index of Consumer Sentiment — are projecting inflation could rise by 3.4% in 2022, nowhere near the approximately 15% peak observed in 1980. In contrast, credit markets proxied by the breakeven inflation rates are projecting that inflation will average just 2.25% over the next 10 years, which signals that even financial markets are not expecting the surge in inflation pressures that was observed between 1970 and 1980.

The lesson learned here is that while all the current inflation pressures may not be transitory, we are led to believe that even when we add the nontransitory inflation pressures, the overall inflation rate is not likely to come even close in 2022 to the alarming peak inflation rate observed between 1970 and 1980.

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About Anthony Chan
Anthony Chan was Managing Director, Chief Economist at JPMorgan Chase & Co. for 25 years. Prior to this, Dr. Chan held the position of Senior Economist at Barclays de Zoete Wedd Government Securities Incorporated. He also was Economist, Domestic Research and Monetary Projections at the Federal Reserve Bank of New York. Dr. Chan holds a PhD in economics from the University of Maryland.