Page 7 - ISQ UK July 2020

JULY 2020

The Fed's balance FED BALANCE SHEET
sheet increased

almost two-fold as
a result of stimulus $ 7.1 Trillion
measures such as $ 4.2 Trillion
the CARES Act. END OF JUNE
LATE FEBRUARY

The Federal Reserve’s (Fed) response to the pandemic was pandemic, lawmakers will have to work to bring the deficit in
quick and forceful. The Fed cut short-term interest rates to line. That doesn’t mean balancing the budget. Rather, we should
effectively zero in early March and restarted asset purchases try to have the national debt stable or falling as a percent of GDP
(‘quantitative easing’). It relaunched liquidity and lending over time. Lower deficits will require higher taxes, cuts to
facilities that it had employed during the financial crisis and entitlement and other spending programs, or some combination.
created some new ones. The size of the Fed’s balance sheet However, there is no rush. The bigger dangers are not doing
rose from around $4.2 trillion in late February to $7.1 trillion at enough to back up the economy in the near term and ending
the end of June. support too soon. Budget austerity may have broad political
support, but it would make the recovery weaker.
BUDGET DEFICITS AND INFLATION Some investors worry that the Fed’s efforts will fuel higher
Many investors are concerned about the government’s ability inflation. This is the same concern that was expressed during
to repay the additional borrowing. However, the government is the financial crisis. Inflation is a monetary phenomenon.
nothing like a household. The government only has to make
interest payments and be able
to roll over maturing debt. That’s Inflation Remains Below Target
not a problem currently. Interest
rates are low and are expected
to remain so over the long term. 12% Personal Consumption Expenditures
While the federal government 10% Personal Consumption Expenditures
has been borrowing more in the Excluding Food and Energy
near term, the Fed has increased 8% Target 2%
its holdings of Treasury
securities. Private savings have 6%
increased and the demand for
safe assets is strong. 4%

Still, the federal budget was on 2%
an unsustainable path before the
pandemic. Federal debt was 0%
rising as a percent of GDP. At
some point, beyond the -2%
1960 1970 1980 1990 2000 2010 2020
Source: FactSet as of 29/5/2020

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