February 18, 2021

How to reduce its balance sheet and return to normalcy without triggering an inflationary spiral or a recession is an issue facing the fed. The ideal path to normalcy would be one where the fed simultaneously reduces its balance sheet and its financial suppression. To do so , the fed must precisely match the increased use of reserves by the banking system as it eases the financial suppression policies to the reduction in the monetary base in such a way that MZM remains unchanged. But is this a likely policy in the near term ? Given the proposed spending by the Biden administration and the fed current pronouncements, we do not foresee the fed reducing its balance sheet in a meaningful way in the near term , nor do we foresee a reduction in the financial suppression policies. A successful roll out of the COVID vaccine yields a bullish inflation outlook. We expect the economy to bounce back strongly as the vaccine is rolled out and people return to work, especially those in the service sector areas. A real GDP growth of 4% or better is not out of the question during 2021. From the fed perspective the reopening and the spending stimulus will add up to a strong economic expansion and according to the Phillips Curve a possible danger of overheating. The Phillips Curve will compel the Fed will move to tighten, to reduce the monetary base and increase the fed funds rate to prevent an overheating of the economy. The Fed actions will reduce the quantity of money while the expansion will increase the quantity of goods. Since we believe that inflation is too much money chasing too few goods, more goods and less money add up to a lower inflation rate, lower than the fed’s projections. The fed will continue to undershoot its target inflation rate .

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