How Nearly Two Decades of Fed Policy Contributed to Bubbles, Busts, and a Boom in Debt (Bloomberg Market, Odd Lots)

Summary (You can listen to the podcast by clicking here)

Srinivas Thiruvadanthai, Managing Director of the Jerome Levy Forecasting Center, explains how the Fed’s goal of inflation targeting is responsible for high leverage.

• Thiruvadanthai believes that inflation trends over the past few decades (excluding the shocks from oil prices) have been stable in the US thanks to how the Fed targets inflation.

• He reiterates that the Fed’s mandate is to keep price level low and stable (less variability). These, in turn, are the culprits behind debt excess in the economy.

• Thiruvadanthai explains that with inflation targeting the Fed signals two promises to credit investors: inflation will not erode the real returns, and real return will be stable year on year. This, in turn, has led to excessive private debt build-up in the economy and new sub-segments of credit appearing such as the junk bond market (inexistant a decade ago).

• He believes monetary policy should be supplemented with fiscal policy and that NAIRU is a flawed concept.

Why does this matter? Based on Thiruvadanthai’s argument, if the Fed fails to keep inflation stable (price low and less variable), there is a potential risk of the private debt market busting (via expectation channel). Currently, private debt to GDP stands at 197%. Potential triggers to inflation include escalation in the US-China trade war and an oil price shock (check out #8 of our Grey Swan exclusive).