# Is the Ghost of Inflation Reappearing?
Author:  Pal Sinha, Barnali 
Author URL: https://financedigest.com/author/pal-sinha-barnali
Published: 2021-05-04
Category: FINANCE
Category URL: https://financedigest.com/category/finance
Meta Title: Rising Inflation Risk: US Economic Outlook 2021
Meta Description: Explore the potential consequences of the extraordinary money supply growth and government spending during the COVID crisis, and its impact on inflation risk.
URL: https://financedigest.com/is-the-ghost-of-inflation-reappearinghtml

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_By **Philip I. Miller,** Strategic International Securities, Inc. CEO_

_**Donald T. Ellenberger,** Federated Hermes Inc. Senior V.P._

It has been more than 40 [years since the United States has experienced any significant inflation](https://www.financedigest.com/spains-inflation-to-be-lower-this-year-than-in-2022-minister.html "Spain’s inflation to be lower this year than in 2022 -minister"). This is despite the fact that the U.S. [debt to GDP ratio will exceed 130% by year end](https://www.financedigest.com/5-common-ways-people-end-up-in-debt-without-realising.html "5 Common Ways People End Up In Debt Without Realising") 2021\. This week the Consumer price index (CPI) was up 0.6% m/m or 7.2% annualized, and the [Producer Price](https://www.financedigest.com/record-jump-in-german-producer-prices-adds-to-gloomy-outlook.html "Record jump in German producer prices adds to gloomy outlook") Index (PPI) similarly was up 1.0% m/m or 12% annualized. Yet there has been limited public discourse, a tepid market response, and virtual denial by the Federal Reserve, of any possible [inflation risk](https://www.financedigest.com/governments-and-central-banks-risk-inflation-bank-of-england-has-done-its-bit-now-the-politicians-turn.html "Governments and central banks risk inflation, Bank of England has done its bit, now the politicians’ turn").

In response to the COVID crisis Congress has passed 3 major Covid bills [costing over $5 trillion](https://www.financedigest.com/floods-other-water-related-disasters-could-cost-global-economy-5-6-trillion-by-2050-report.html "Floods, other water-related disasters could cost global economy .6 trillion by 2050 -report") which has been largely underwritten by the Federal Reserve, pushing money supply growth off the charts. The Federal [Reserve’s response to this extraordinary expansion of money](https://www.financedigest.com/u-s-money-reserve-reviews-real-talk-about-diversifying-with-precious-metals.html "U.S. Money Reserve Reviews: Real Talk About Diversifying With Precious Metals") supply, was to limit their reporting of the money supply data from weekly to now only monthly, after more than a half century of weekly reporting.

This [Covid response](https://www.financedigest.com/pfizer-biontechs-updated-covid-shot-shows-strong-response-against-bq-1-1.html "Pfizer/BioNTech’s updated COVID shot shows strong response against BQ.1.1"), while necessary, poses some major unanswered macroeconomic questions, with long term implications for the economy, specifically: Are there limits to government spending, without any long-term consequences?  Economic theory says “Yes”, but the [markets and the current Fed](https://www.financedigest.com/markets-start-signalling-fed-may-be-going-too-far-amundi.html "Markets start signalling Fed may be going too far – Amundi") leadership appear to be saying “NO” at least for now.

**The Federal Reserve Accord of 1951 – Is [history Repeating](https://www.financedigest.com/feds-job-friendly-soft-landing-hinges-on-history-not-repeating.html "Fed’s job-friendly ‘soft landing’ hinges on history not repeating") itself?**

Since the Federal Reserve Accord of 1951, U.S. fiscal policy and the Federal Reserve’s [monetary](https://www.financedigest.com/asian-economic-powers-warn-of-risks-from-war-monetary-policy-normalisation.html "Asian economic powers warn of risks from war, monetary policy normalisation") policy initiatives, have been predominately independent of one another. The Fed described the accord as:

_“In March 1951, the US Treasury and the Federal Reserve reached an agreement to separate government debt management from monetary policy, laying the foundation for the modern Fed.”_

Since the COVID crisis, for the first time since the Accord the Fed has been forced to cross the Rubicon, using its presumably infinite [balance sheet](https://www.financedigest.com/ecb-policymakers-back-jumbo-rate-hike-differ-on-balance-sheet-cut.html "ECB policymakers back jumbo rate hike, differ on balance sheet cut") to underwrite trillions of dollars of Treasury debt, and essentially shredding its recent historical independence.

In 1993 in a Federal Reserve Newsletter on the 1951 Federal Reserve Accord with the Treasury, Carl Walsh of the Federal Reserve Bank of San Francisco wrote:

_“Whenever a central bank adopts a policy of pegging market interest rates, it [gives up control over the supply of money](https://www.financedigest.com/nearly-half-of-parents-still-give-pocket-money-to-their-adult-children.html "Nearly half of parents still give pocket money to their adult children"). If the pegged rates are [set too low](https://www.financedigest.com/dollar-steadies-near-16-week-low-yuan-set-for-biggest-weekly-gain-since-2005.html "Dollar steadies near 16-week low, yuan set for biggest weekly gain since 2005"), private sector demand for new government debt issues will be too small to take up the entire issue._

Since the [Fed has placed the interest rate](https://www.financedigest.com/oil-dips-as-potential-fed-rate-hike-overshadows-falling-stocks.html "Oil dips as potential Fed rate hike overshadows falling stocks") at the zero bound, which is too low to clear the market, given the Covid stimulus spending, the Fed has had to step in as the buyer of last resort, causing the growth rate of money supply to go off the charts, and possibly risking high inflation. Since mid-2020 the Fed has been breaching the “limit principle” on money [growth which was the primary](https://www.financedigest.com/construction-machinery-sector-is-primary-growth-factor-for-industrial-hydraulic-filters-market-unveils-fact-mr.html "Construction Machinery Sector Is Primary Growth Factor For Industrial Hydraulic Filters Market, Unveils Fact.MR") reason for the 1951 Accord.

**[Rising government debt + rising money supply = inflation](https://www.financedigest.com/shares-rise-but-concern-mounts-over-inflation-flare-up.html "Shares rise, but concern mounts over inflation flare-up") risk**

In a classic 1981 study on the limits of government spending, [Nobel prize](https://www.financedigest.com/nobel-medicine-prize-goes-to-explorer-of-ancient-dna.html "Nobel medicine prize goes to explorer of ancient DNA") winning economist Thomas Sargent and Neil Wallace (SW) argued that if a fiscal authority’s deficits cannot be sufficiently financed by foreign and domestic demand to absorb all the debt used to finance government spending, the Fed is forced to become the buyer of last resort, and thus crossing the Rubicon of independence and sound monetary management.

This scenario has historically led to high levels of [inflation every time](https://www.financedigest.com/love-in-a-time-of-inflation-how-much-will-valentines-day-set-you-back.html "Love in a time of inflation: how much will Valentine’s Day set you back?") according to an exhaustive review of 133 countries and close to 45,000 observations by Stanley Fischer, Sahay, and Vegh (FSV) from 1957 to 1998. FSV found that in every instance when excessive budget deficit reaches what is known as the “limit principle,’’ currency weakness, inflation, and high real [interest rates](https://www.financedigest.com/interest-rate-and-recession-fears-knock-stocks-and-oil.html "Interest rate and recession fears knock stocks and oil") follow.

Already, the U.S. dollar, and the 10-year benchmark treasuries have weakened, a clear early sign of inflation. Despite economic theory and empirical evidence pointing to limits on the Federal Reserve’s underwriting of government debt, without consequences, Fed [officials have consistently downplayed any negative ramifications from the Fed’s monetization of Treasury](https://www.financedigest.com/italy-names-former-treasury-official-to-head-ita-airways.html "Italy names former Treasury official to head ITA Airways") debt.

The government created the recession of 2020 to contain the coronavirus.  In response, the government has poured trillions of [dollars into business and consumer pocketbooks to bridge the gap between the economy’s](https://www.financedigest.com/stocks-dollar-gain-on-resilient-u-s-economy.html "Stocks, dollar gain on resilient U.S. economy") shutdown and its staggered restart.  This caused federal debt burdens to spike higher, and for the first time in decades the [Fed acted as buyer of last resort by printing money and effectively monetizing the debt increase to keep interest rates](https://www.financedigest.com/wall-st-heads-higher-as-fed-rate-hopes-dent-dollar.html "Wall St heads higher as Fed rate hopes dent dollar") below market-clearing levels.  The result has been a massive increase in money supply that history shows typically results in [higher inflation](https://www.financedigest.com/boes-saunders-worries-inflation-will-be-higher-than-forecasts.html "BoE’s Saunders worries inflation will be higher than forecasts") down the road.  The Fed has stepped across the Rubicon, by allowing its balance sheet to be controlled by politicians, it has breached the limit principal, creating the [risk of higher inflation](https://www.financedigest.com/high-inflation-recession-risk-widen-ecb-dilemma.html "High inflation, recession risk widen ECB dilemma"). This is not a Democratic or a Republican argument, it is simply an economic issue that needs enhanced visibility, as we try to traverse this [Covid crisis](https://www.financedigest.com/analysis-covid-crisis-could-deepen-n-korea-food-shortages-amid-drought-warnings.html "Analysis-COVID crisis could deepen N.Korea food shortages amid drought warnings").


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