Jan. 30, 2023

Did The Stimulus Cause Inflation?

There is a remarkable correlation between the current bout of Inflation and those Stimulus Checks we all received a couple of years ago. What makes this so critical and timely is that the Federal Reserve will meet this week to determine our next interest rate setting. And their decision will be based, at least in part, on where this Inflation came from.

Wall Street is convinced that, once again, the Fed will raise interest rates. And each time the Fed raises rates, they repress the economy. So, this nearly year-long campaign toward higher interest rates has suppressed economic activity at a time when we are particularly vulnerable to an economic slowdown/recession.

What if raising interest rates right now is the wrong action for the Fed to take? That this is not traditional financial overheating and excess demand? What if those Government Stimulus Programs caused current Inflation? That's my thesis.

Before we begin a couple of ground rules, first, we will use the Fed's favorite measure of Inflation, the Personal Consumption Expenditures Index. We can find this measure of the rise in prices (Inflation) in the GDP Report released last week.

Let's not quibble here on this particular reading for Inflation. It is what it is. The PCE Index hit a high last June of nearly 7% and, in this latest report, came in at a 5% annual inflation rate. And the PCE Index is the measure of Inflation that the Fed will use to set interest rates.

My next point is a subtle one but extremely important. It has to do with the way we view this Inflation Index. Most of us have seen the rise in Inflation, as presented in our first chart. It shows that Inflation is constantly rising, with the left side much lower than the right side of the chart. So, that must mean that Inflation is getting worse and worse.


No, not really.

In investing, we call this a mountain chart. In one sense, it does show the compounding effect of Inflation over time. For instance, it shows that a 2015 dollar is worth more than a 2023 dollar because the 2023 dollar is reduced by Inflation.

Unfortunately, that's a given in our economy. Inflation is always and forever eating away at our purchasing power. We have a systemic problem with Inflation. But that's not the Fed's concern. And it's different from what we're addressing today.

The Fed is concerned with the rate of change in the current Inflation. The Fed has repeatedly said that they would be delighted if Inflation was at an annual rate of 2%. They've made that their price target.

So going back to our chart, we will always see the left side of the chart lower than the right. Unfortunately, there is always going to be Inflation in our system.

We, and the Fed, would like to see the acceleration in current Inflation slow. In other words, we're looking for a decline in the "rate of change" in Inflation.

So, let's take a look at another chart. It is a chart that shows Inflation's rate of change, quarter by quarter.

However, before we look at the chart, let me remind you when we all received those Stimulus Checks. The IRS directly deposited Stimulus Checks into taxpayers' bank accounts in April 2020. Stimulus One totaled $1.9 trillion.

The Second Stimulus checks hit bank accounts beginning in December 2020 and took a couple of months to complete this Stimulus Packaged totaled $900 Billion.

Finally, IRS sent the third and final Stimulus in March of 2021, total distribution in this Package of $1.9 Trillion.

In total, IRA and Treasury sent nearly $5 Trillion directly to taxpayers around the country. That's a $5 Trillion flood of cash into an economy that each year has a total income of only a little over $20 Trillion. All those extra dollars have had a tremendous impact on prices.

So that was three tranches of Stimulus, beginning in April 2020, then December, and finally in March 2021.

                                      Inflaton's change per quarter

Now let's look at our second chart, taking into consideration that there is a lag time between the beginning IRS beginning the stimulus transfers and eventually hitting your bank account. And there may have been other delays between receiving funds and spending the money.

This new chart shows the rate of change from the month before. Note tremendous change in Q3 2020. Suddenly inflation skyrockets. Until then, we saw no higher change, quarter to quarter, than 1%. You can go back for years before and see that Inflation never increased by more than 1% for any quarter.

But suddenly, in that third quarter of 2020, just as we spent the Stimulus Checks. More than ever, Inflation roars ahead by 4%—a perfect correlation with those first stimulus checks.

Again in the first quarter of 2021, we see a big jump in Inflation, coming in at two and a half times the average rate. Again a perfect correlation with those second stimulus checks, which went out beginning in late December.

The final jump in Inflation came in the second quarter of 2021 and again correlated with the Stimulus Checks sent out beginning in March of 2021.

Since all this activity, Inflation has returned to its average rate of increase, 1% or less, with a slight deviation in Q1 of last year.

That is until reached the third quarter of 2022. Then the rate of increase in Inflation drops through the floor. In one of the most significant declines ever, outside of a major recession or depression, the rate of change in Inflation declined by nearly 4%, and this latest quarter just reported the rate of change in Inflation is down by more than 1 1/2%.

Inflation is dropping like a stone.

So let's sum up. That first look at Inflation (the mountain chart) is like the odometer in your car. It tells you how far you've gone. How many miles you've traveled to reach your destination? It's a handy tool, but limited.

The second chart, the rate of change in Inflation, is like your car's speedometer. It's the primary instrument you use when driving. You know, for instance, that you're coming to a stop as the speedometer approaches zero.

Today we know that the inflation speedometer is slowing and slowing rapidly. Soon we will be coming to a stop in Inflation (at least below the Fed's 2% target), with the result of a reduction in economic activity and the risk of recession.