Skip to main content

You are here

Blog Listing Page

US inflation – why this time is different

By: Tom Goodwin, PhD, senior research director

A classic Aesop’s fable tells the tale of a shepherd boy who repeatedly tricks villagers into thinking wolves are attacking his flock. The villagers start ignoring him after several false rounds of “crying wolf.”

Something similar is going on in the markets at the moment. We have recently had a sharp uptick in volatility and a correction in the equity market. Pundits have been pointing fingers at several factors, but inflation expectations are frequently cited as one of those factors.[1]  

Here is where old Aesop becomes current. Since 2008 when the Fed began its program of zero interest rates and quantitative easing, many economists, pundits and politicians have sounded alarms about a coming wave of inflation. It never appeared. In fact, the Fed has struggled to get core inflation up to its 2% target. After years of “crying wolf” it is perhaps natural for many market participants now to ignore any inflation warnings. But remember the end of the tale: a pack of wolves do attack the flock, the shepherd boy sounds the alarm, but the villagers ignore him and the flock is devoured.

The previous inflation concerns were based on widely accepted models of the transmission mechanism between monetary policy and subsequent inflation, according to which such a massive increase in liquidity by the Fed should have led to double digit inflation and interest rates. Fortunately for everyone, the Fed under Ben Bernanke recognized that the financial crisis had left the economy in a condition called a “liquidity trap” and the standard monetary models no longer worked as in the past. The Fed stayed the course and helped bring us out of the recession without inflation.

What is different this time is that the inflation pressure is coming from fiscal policy, not monetary policy. Congress and the President just agreed to an increase in debt-financed government spending by $300 billion over the next two years. This comes on top of a $1.5 trillion tax cut signed into law last December. Historically speaking, this huge fiscal stimulus arrives at an odd time with respect to the stage of the business cycle.[2] Many macro models suggest that this level of stimulus might have done a lot of good five years ago when unemployment was high and industrial capacity was slack, but now US GDP growth is high and rising. Additional demand from government, business and consumers may lead to “cost-push” inflation, where wages and prices of increasingly scarce labor and industrial inputs are bid up without a compensating increase in productivity.

The bond market has noticed. The chart shows that inflation expectations as measured by “breakeven inflation” started edging up in late November when the details of the tax bill became clear and then increased sharply again in early January as the details of the new budget became clear.[3] It has since come off its high of 2.14%, mainly because of a dip in oil prices. This is not yet at alarming levels, but it is higher than it’s been in several years.

Economists aren’t sure how much the tax cut and spending increase will boost growth. But there is concern that inflation will rise above the 2% target and the Fed will have to react. Many economists have now revised their estimates of the number of rate rises in 2018 from three to four.[4]    

We are in the midst of a major policy switch. Whereas before monetary policy was pedal-to-the-metal while fiscal policy was neutral to austere, now the roles have reversed. Fiscal policy will inject massive new deficit spending into the US economy this year and next, and monetary policy will have to put the brakes on any inflationary tendencies with higher interest rates. This time really is different.



[1] Eric Morath and Kathryn Tam, “Should Markets Be Worried About Inflation?” Wall Street Journal, February 7, 2018.

[2] Lev Borodovsky, “Fiscal Stimulus Rivaled Only by the Korean and Vietnam Wars,” Wall Street Journal, February 12, 2018.

[3] The compound difference between the yields on the 10 year Treasury note and the 10 year Treasury-Inflation-Protected-Security (TIPS) is known as “breakeven inflation” because it is the 10-year rate of inflation that will produce equal returns from both instruments after adjusting for inflation, if that rate of inflation is realized.  

[4] Nick Timiraos, “Spending Bill Raises Expectations for More Rate Increases,” Wall Street Journal, February 20, 2018.


© 2018 London Stock Exchange Group plc and its applicable group undertakings (the “LSE Group”). The LSE Group includes (1) FTSE International Limited (“FTSE”), (2) Frank Russell Company (“Russell”), (3) FTSE TMX Global Debt Capital Markets Inc. and FTSE TMX Global Debt Capital Markets Limited (together, “FTSE TMX”) and (4) MTSNext Limited (“MTSNext”). All rights reserved.

FTSE Russell® is a trading name of FTSE, Russell, FTSE TMX and MTS Next Limited. “FTSE®”, “Russell®”, “FTSE Russell®” “MTS®”, “FTSE TMX®”, “FTSE4Good®” and “ICB®” and all other trademarks and service marks used herein (whether registered or unregistered) are trade marks and/or service marks owned or licensed by the applicable member of the LSE Group or their respective licensors and are owned, or used under licence, by FTSE, Russell, MTSNext, or FTSE TMX.

All information is provided for information purposes only. Every effort is made to ensure that all information given in this publication is accurate, but no responsibility or liability can be accepted by any member of the LSE Group nor their respective directors, officers, employees, partners or licensors for any errors or for any loss from use of this publication or any of the information or data contained herein.

No member of the LSE Group nor their respective directors, officers, employees, partners or licensors make any claim, prediction, warranty or representation whatsoever, expressly or impliedly, either as to the results to be obtained from the use of the FTSE Russell indexes or the fitness or suitability of the indexes for any particular purpose to which they might be put.

No member of the LSE Group nor their respective directors, officers, employees, partners or licensors provide investment advice and nothing in this communication should be taken as constituting financial or investment advice. No member of the LSE Group nor their respective directors, officers, employees, partners or licensors make any representation regarding the advisability of investing in any asset. A decision to invest in any such asset should not be made in reliance on any information herein. Indexes cannot be invested in directly. Inclusion of an asset in an index is not a recommendation to buy, sell or hold that asset. The general information contained in this publication should not be acted upon without obtaining specific legal, tax, and investment advice from a licensed professional.

No part of this information may be reproduced, stored in a retrieval system or transmitted in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without prior written permission of the applicable member of the LSE Group. Use and distribution of the LSE Group index data and the use of their data to create financial products require a licence from FTSE, Russell, FTSE TMX, MTSNext and/or their respective licensors.

Past performance is no guarantee of future results. Charts and graphs are provided for illustrative purposes only. Index returns shown may not represent the results of the actual trading of investable assets. Certain returns shown may reflect back-tested performance. All performance presented prior to the index inception date is back-tested performance. Back-tested performance is not actual performance, but is hypothetical. The back-test calculations are based on the same methodology that was in effect when the index was officially launched. However, back- tested data may reflect the application of the index methodology with the benefit of hindsight, and the historic calculations of an index may change from month to month based on revisions to the underlying economic data used in the calculation of the index.

This publication may contain forward-looking assessments. These are based upon a number of assumptions concerning future conditions that ultimately may prove to be inaccurate. Such forward-looking assessments are subject to risks and uncertainties and may be affected by various factors that may cause actual results to differ materially. No member of the LSE Group nor their licensors assume any duty to and do not undertake to update forward-looking assessments.

Blog Listing Page