Future Low Inflation Begs For Expansionary Fiscal Policy

Following on top of the most recent positive unemployment report, it also appears that the latest inflation figures are at or near the Fed target of 2%.  The numbers released on Friday show that the mean Consumer Price Index (CPI) is running at an annual rate of 2.2% and the trimmed-mean CPI came at a 1.9% annual rate. The CPI for urban consumers is up to 2.6% and the CPI less food and energy also rose to 2.1% annualized. Core CPI was up to 2.3% but, as Dean Baker points out, that number falls to 1.4% when the costs of shelter are excluded, highlighting rising rents driven by housing shortages.

On the other hand, yields on sovereign bonds all over the world are falling into negative territory, signaling markets believe that these record low interest rates will be with us for year to come. Germany’s recently issued 10 year bond auctioned at a negative yield, joining Switzerland and Japan with that dubious distinction in the last year.  What this means is that investors are actually loaning money to Germany and PAYING for the “privilege” to do that. Investors will get less money back than they loaned if they hold the bonds to maturity.  There are a number of reasons for this insanity – investors think bond prices may rise further, driving yields further into negative territory, and they can sell at a profit; many funds are required to have a certain percentage of their holding in safe and liquid sovereign bonds so they have no choice; and with the rampant global uncertainty, there just not that many safe investment options out there.

These two conflicting indicators, higher current inflation but lower inflation expectations, present a real conundrum for the Fed. Thankfully, they can wait for another month or two of data to see if any specific trend develops before they have to make any decisions about changing interest rates. Even so,  I wouldn’t expect any decisions until after the election this fall.

While the Fed is dealing with monetary policy, you would think that fiscal policy makers might want to think about the implications of these negative yields. When people are actually paying you to take their money, you might want to think about doing something with that money. Rather than focusing on destructive austerity as fiscal policy makers have done since 2010, they might want to invest in growing their economies. In fact, in the wake of the Brexit vote in the UK, Theresa May has already replaced George Osborne and indicated that the days of austerity are over. And with centrist European governments under stress from both the left and the right, you have to wonder how long austerity can last in Europe.

Here in the US, there are billions of dollars that could be spent on updating and improving our nation’s infrastructure. One of the biggest reasons for the dynamic US economy in the post World War II era was the creation of the nation’s highway system under President Eisenhower, an incredible investment that still pays dividends for our country today. Other options would also include spending on policies that are proven to help increase employment, like job training.  A new study shows that properly focused job training can allow trainees to earn $2,000 more than those that did not participate. And there are plenty of other similar projects out there. The deficit scolds will continue to tell us that “we can’t afford it”, but a faster growing economy will actually REDUCE our debt-to-GDP ratio especially when interest rates stay at such ridiculously low level. OF course, this is a non-starter in our current Congress but we can at least hope things change with the election this fall.