A little like teenagers watching their parents let loose on the dance floor at a wedding, the stock market this week seemed to be looking on in horror at what appeared to be policymakers’ complete lack of fiscal and monetary rectitude in the face of a surge in inflationary pressures and a rapidly rebounding economy. The bond market, for its part, has played it a little cooler; perhaps like an older sibling, it’s slightly less bothered by the parents’ sock hopping and just waiting for the next slow dance to hit the turntable.
With the Fed no longer taking a preemptive tightening policy stance and the Biden administration attempting to pump a total of $6 trillion into a $22 trillion economy, the growing fear is that economic growth will be/is already plowing straight through its non-inflation accelerating speed limit for growth. The concern is that we will soon end up with devastating inflation and a Fed having to swiftly, and aggressively, ratchet up interest rates.
It would be negligent to say that such an outcome is not possible, even though it still may not be the most likely one at the moment. In reality, these policymakers are engaged in a very bold experiment, a bet that the economy’s speed limit is not written in stone and that engaging in policies to run the economy hotter than what might otherwise seem acceptable can actually help to increase its productive capacity, and lift that speed limit to a higher equilibrium limit. In this week’s Economics Weekly, we outline the Fed’s—and the Biden administration’s—strategy about the economic recovery, and why they are attempting to run it hot.
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Richard de Chazal, CFA is a London-based macroeconomist covering the U.S. economy and financial markets.