into the economy at a record pace to try to fight

a global recession triggered by the coronavirus

pandemic. Just getting word from the Federal

Reserve. Bombshell announcement from the Federal

Reserve. It is an absolutely historic week both

in the terms of the speed of Fed purchases and, of

course, the magnitude.

Since mid-March, the Federal Reserve's balance

sheet has ballooned from 4 trillion dollars to

around 7 trillion dollars, equal to about one

third of the value of the entire American

economy. A new CNBC survey showing that market

participants expecting trillions more in stimulus

from both the central bank and Congress.

At the same time, governments have enacted record

amounts of fiscal stimulus to boost economies

stalled by the pandemic.

The infusion of cash into the financial system

has renewed concerns that inflation could surge.

As Milton Friedman said, inflation is always and

everywhere a monetary phenomenon.

If you believe that, you look at the central bank

balance sheets exploding right now and you say

there's going to be inflation.

Supply shocks have driven up prices for some goods

over the past few months.

Yet recent history suggests inflation is more

likely to stay low for a long time as

unemployment remains near record high levels and

consumer spending is subdued.

While this certainly is quite a lot of disruption

to the supply side of the economy, that's likely

to be dominated by the huge hit to aggregate

demand. So how will trillions of dollars of

economic stimulus affect the outlook for

inflation?

Inflation refers to an increase in the prices of

goods or services over time.

One well-known measure of inflation in the U.S.

is called the Consumer Price Index, or CPI.

The CPI is about the prices that we pay for

services and goods and housing and rent.

Economists say some inflation is healthy for the

economy. When the economy's growing, more

consumers and businesses are out spending money

on goods and services.

This increase in demand results in higher prices.

Demand is an important factor in the outlook for

inflation. Generally, when unemployment is high

and consumer demand is weak, inflation is low.

Another factor that affects inflation is commodity

prices. If oil prices rise because there's a cut

in production, gas prices might increase too.

Consumer and business expectations about prices

are another piece of the inflation puzzle.

If a lot of people expect prices will rise in the

future, they might spend more now, ultimately

causing inflation. The level of actual inflation

that we get will be pretty heavily influenced by

the inflation rate that actors in the economies,

households, businesses, consumers, workers,

investors expect to prevail.

Like many other central banks around the world,

the Fed targets a 2 percent yearly inflation

rate. At that rate, a cup of coffee that costs 2

dollars this year would cost 2 dollars and 4

cents next year, not quite enough to break the

bank. Central banks adjust their policies

normally by changing interest rates to try to get

to that 2 percent inflation level.

You definitely want to keep enough inflation so

you can still have enough space to raise and

lower Fed funds over the business side.

Too much inflation isn't a good thing either.

As inflation rises, the money that you hold today

becomes less valuable tomorrow.

At a 15 percent inflation rate, for example, your 2

dollar cup of coffee today costs 2 dollars and 30

cents next year.

Think of how that would affect a bigger purchase

like a car. A ten thousand dollar purchase today

would cost eleven thousand five hundred dollars

next year. When the inflation rate is very

high, it is very difficult to make any calculation

about saving.

Inflation concerns for now are to the downside.

The risks are to the downside, not to the upside.

We see prices moving down.

That's because in a lot of parts of the economy,

people are cutting prices.

Lockdown's have already depressed prices in the US

as consumers stay home and remain cautious about

spending money in an uncertain economy.

The second biggest drop in headline inflation

since 1947.

Energy commodities down 20 percent, with a 20

percent decline in gasoline.

Fuel oil down 15 percent.

There have been pockets of inflation in some

areas, like groceries as more people cook at

home. Disruptions in global trade from the virus

have also raised prices for goods like medical

supplies. Still, these supply shocks haven't

offset overall weak demand.

If you're in the average person's seat, we're

talking about, you know, grocery stores and that

sort of thing. The idea that there's going to be

an outbreak of inflation, you know, 4 percent, 5

percent, that is just not on the horizon.

Many economists and policymakers expect wages will

stay low as unemployment remains high.

Meanwhile, people are saving instead of spending

their cash out of fear the economy could get

worse. To try to

boost the economy, policymakers in Washington

have pumped trillions of dollars into the

financial system in recent months.

Economic theory suggests all this money printing

could create the risk of inflation.

Economist Milton Friedman famously said that if

there's too much money in the economy, chasing

too few goods prices will rise.

When inflation was surging in the 1980s, Fed

Chairman Paul Volcker put Friedman's theory to

the test, and it worked.

Volcker slowed the growth of money going into the

economy and raised interest rates to tame

inflation. But economists say there's been a

break in the link between money creation and

inflation in recent years as the banking system

has become more complex.

The rise of the financial system and the sort of

the diversification of the financial system is

one of the reasons why sort of the Milton

Friedman view of the world really is not as

applicable, particularly in the United States, as

it was in an earlier time.

It's important to understand that when the central

bank prints money today, most of it isn't in the

form of physical dollar bills.

Instead, the Fed creates electronic money.

It uses that electronic cash to buy assets and

lend to banks, injecting money into the banking

system. To buy treasuries, for example, the Fed

uses so-called primary dealers, a group of around

two dozen big banks and brokerage firms that

trade bonds. What happens when the Fed creates

money? It strictly creates central bank reserves.

Those are held by the banking system.

The banks decide, you know what what they're

willing to lend out into the economy.

That means that even if the Fed is pumping a lot

of money into banks like it is today, the money

won't reach the hands of consumers until banks

lend it out. It is true that money has been

handed out directly to citizens as part of the

federal government's coronavirus response, like

the 1,200 dollar stimulus checks.

This cash infusion still may not result in

inflation. Most Americans needed the checks to

make day to day payments to make up for lost

income during the crisis.

Not to go out and spend lavishly on other

purchases. I think of them as more life

preservers, trying to prevent the economy from

getting into a deeper hole because of the Kovik

crisis. And they don't represent stimulus yet.

Recent history suggests that all the fiscal and

monetary stimulus daring the pandemic is unlikely

to increase prices for consumers when the Fed

bought trillions of dollars of assets after the

2008 financial crisis, inflation never surged.

After the Great Recession, there was a conviction

that all the fiscal and monetary stimuli were

going to result in huge inflation.

As a matter of fact, a number investors,

including some very famous hedge funds, went to

gold. Well what happened?

Big deficits, but inflation has come down.

The experience of the last decade is that central

bank balance sheet expansion certainly need not

generate a period of excess inflation.

And in fact, even with a big balance sheet to be

hard to get the inflation that you want.

There are limits to what history can teach us when

it comes to understanding the economic situation

right now. Even if the economic stimulus doesn't

result in higher prices for consumers, many say

that inflation is showing up in the prices of

other assets like the stock market or the housing

market. One of the most interesting questions

that we have right now is the difference between

the price inflation that you and I see at the

grocery store or at the gas pump or when we're

buying something.

That's one measure of inflation.

But another measure of inflation that is also

very important is asset price inflation.

In other words, what's happening to the stock

market and what's happening to credit spreads?

I think we're looking at a very significant

increases in asset price inflation.

Inflation expectations are another risk.

People start thinking all of the money supply is

increasing. Inflation is going to be higher.

Then expected inflation becomes high.

Then you start asking for increases in wages and

prices. And these expectations become what we

call self-fulfilling.

In the long term, factors like globalization,

technology and aging populations all play a role

in consumer prices.

A weaker U.S. dollar or a backlash against global

supply chains, which have been disrupted during

the pandemic, could create inflation risks.

If you were to seal the borders and literally cut

off any imports and then embark on this huge

monetary and fiscal stimuli, yeah, they could

they could create inflation.

There's one more big risk to inflation, and it

comes with nine zeros attached.

Record high public debt.

Trillions of dollars in economic stimulus during

the pandemic have increased government debt at a

rapid pace.

In recent years, some economists have argued in

favor of deficit spending to fund public

investment. Though many debate what effect this

could have on inflation.

Because government debts are set in fixed dollar

amounts, higher inflation makes it easier to pay

off those debts.

Some worry that politicians might put pressure on

central banks to chase higher inflation to help

finance the growing national debt.

We need not worry too much about the size of the

Fed's balance sheet.

What we need to be focused on is whether the Fed

will at the appropriate moment have both the

judgment and the institutional independence to

raise interest rates, even if that might conflict

with some other interests, for instance, the

interest of the government of today.