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).
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