The Economic Recovery Is Here But Keep An Eye on Inflation Risks

Energized by record high levels of government stimulus money and the Fed’s easy monetary policies, the latest reports on the health of the economy, provide strong confirmation that it has fully recovered from the devastating impact of the Covid-19 pandemic.

In 2020, as the Covid-19 pandemic continued to expand, the US economy contracted at its deepest pace since World War II contributing to reductions in consumer expending, stagnation in business investment and supply-chain disruptions that pushed millions of Americans out of work and contributed to increases in poverty levels in communities across the nation.

During these challenging times, the economy experienced a contraction of 19.2% from its peak in the fourth quarter of 2019 through the second quarter of 2020, recording its biggest contraction since 1946. Consumer spending the main engine of growth in the economy accounting for more than two-thirds of economic activity fell by 10.1% in Q2 2020 compared to Q1 2020, its worst quarterly performances on record.


 To help the economy recover, the Fed cut interest rates to zero (March 15, 2020) and restarted its large-scale asset purchases (QE) of $ 120 billion a month ( $80 billion of Treasury securities and $ 40 billion Agency Mortgage-Backed Securities (MBS) per month), key driving factors that  have provided  the economy the stimulus required to establish the foundation for a sustainable recovery as progress across different sectors have recently shown: wide availability and access to vaccines, business re-openings, reductions in unemployment and strong consumer demand.

Although the impact of the Fed’s easy money policies and additional government stimulus currently under consideration ( $ 1 trillion infrastructure bill and $3.5 trillion of other government spending) are the major forces driving the current economic recovery, there are growing concerns that a continuation of the Fed’s easy monetary policies and additional spending legislation now in Congress could contribute to the economy overheating and accelerate the resurgence of inflation with its many negative repercussions to consumers, markets and the economy.

As recent reports on the health of the economy show, the massive levels of fiscal stimulus and the Fed’s ultra-easy monetary policy have been major factors driving the recent upsurge in consumer demand and supply-chain disruptions, factors that are accelerating the resurgence of inflation as recently experienced across key sectors of the economy: home prices, car and gas prices. An inflation indicator closely monitored by the Federal Reserve showed an increase of 3.5% in June 2021, relative to prices in June 2020.

As the economy continues on its path to a full recovery with employment levels gradually returning to pre-pandemic levels and more Americans get vaccinated, a continuation of current policies to provide additional fiscal and liquidity stimulus to the economy would be hard to justify, since a continuation of these policies would inevitably contribute to the economy overheating and lead to the unwelcome resurgence of inflation in the economy.

It is hoped that the continuation of the current economic recovery and recent reassuring reports about the improving strength of the labor market will lead the Fed to reassess its current policy of overstimulating the economy and to  begin to easy-off its injection of liquidity into the economy.

Today, capital markets cautiously wait for the Fed to decide how and when, it will decide to start tapering its bond buying program of $120 billion a month of Treasury bills and mortgage-backed securities.