The extraordinary crises in the world economy over the last several years have led to an equally extraordinary monetary response from the Federal Reserve. Some six trillion dollars have been created since 2008 by the world's major central banks to cushion financial markets and ease deflationary pressures. The Fed has more than tripled the size of its balance sheet since the crisis began, holding short-term interest rates near zero since the end of 2008 and embarking on several rounds of "quantitative easing" in an effort to push down longer-term rates and stimulate economic activity.
Many individual investors worry about the Fed's easy monetary policies, both because a prolonged period of low interest rates reduce savers' incomes and because expansion of the Fed's balance sheet raises the prospect of eroding savers' future buying power via inflation. The possibility of future inflation has pushed many investors into Treasury Inflation Protected Securities, which have become so popular that their yields have sometimes turned negative, meaning that investors are paying the government for some insurance against inflation. The increase, and increasing volatility, in gold prices are also an indication of inflation worries, as investors pile into an asset that has historically held its value when paper currencies have not.
It's important, though, not to overstate worries about the Fed's actions. Although the Fed has dramatically increased its balance sheet, that increase in the money supply has yet to have much of an impact on savers' purchasing power. Government statistics show an average inflation rate since the start of 2008 of under 2%, lower than the rate from 2000 through 2007, and market expectations of future inflation are similarly low. In fact, many economists think that the Fed has erred on the side of doing too little rather than too much, and that it should be open to a higher inflation rate in order to reduce unemployment.
Of course, markets have been known to be wrong, and when conditions improve the Fed may turn out to be unable to move quickly enough to tighten monetary policy and prevent inflation. But for now, the Fed's monetary easing seems unlikely to erode investors' buying power unless and until the economy does improve, putting people back to work and driving up demand for goods. That would be bad for fixed income investors, but a balanced portfolio that includes equities should gain more from an economic recovery than it will lose from inflation.
This article was made possible by support from OppenheimerFunds.