Swedroe: Easy Monetary Policy = Inflation?

August 11, 2014

Don’t believe everything market forecasters tell you.

One of the more persistent themes we’ve been hearing from forecasters, for quite some time now, is that the Federal Reserve’s easy monetary policy—starting with its move to drive the Federal Funds rate from 5.25 percent to zero—would inevitably lead to a dramatic spike in inflation.

As each new round of quantitative easing (QE) was announced, the chorus only grew louder. We’ve now had QE1, QE2 and QE3. As a result of those bond buying programs, the Fed’s balance sheet has more than quadrupled, from less than $1 trillion to more than $4 trillion.

Since it’s now been more than six years since the Fed first took action to address the financial crisis, I thought it would be worthwhile to take a look at how the many predictions of rampant inflation have played out.

Let’s begin by reviewing the consensus forecast for inflation from the Federal Reserve Bank of Philadelphia’s first-quarter 2008 Survey of Professional Forecasters. The consensus forecast for the five-year period from 2008-2012 called for an inflation rate of 2.4 percent. The 10-year forecast called for an inflation rate of 2.5 percent.

It turns out that, despite all the bleak forecasts, the actual rate of increase in the consumer price index (CPI) from 2008 through 2013 was just 1.7 percent—1.4 percentage points below the previous historical average of 3.1 percent. And as of the end of June 2014, the increase in the CPI over the prior 12-month period was a still low 2.1 percent. While the consensus forecast of professional economists was a bit too high, it certainly was more accurate than the forecasts of the doom-and-gloomers.

The dire predictions of rising inflation caused many investors to limit their bond holdings to the shortest maturities. That led such investors to miss out on the strong returns provided by longer-maturity bonds. For example, from 2008 through June 2014, one-year Treasurys returned just 1.2 percent per year, while 5-year Treasurys returned 4.5 percent per year and 20-year Treasurys returned 6.8 percent per year.