Why The Federal Reserve's New Approach To Inflation Makes Sense

Last week, Federal Reserve Chairman Jerome Powell said the Fed will be making a subtle shift in the approach to its 2% inflation target.

On Monday, Mizuho chief economist Steve Ricchiuto said the shift in Fed mindset may be more important than investors realize in the long-term — and it should be good news for the SPDR S&P 500 ETF Trust SPY.

Ricchiuto said his initial reaction to Powell’s comments was that it has taken the Fed a long time to recognize an important shift in the U.S. economy.

“Makers of monetary policy had finally recognized the fundamental shift in the economy from excess demand to excess supply that had been slowly taking place since Ronald Reagan introduced his supply-side tax cuts back in August 1981,” the economist said Monday.

Excess Supply Vs. Excess Demand: Since the 1980s, Ricchiuto said the Fed has been operating under the assumption that the biggest risk to the U.S. economy is hyperinflation driven by undersupply.

“In a world of excess demand, the Fed’s responsibility is to take away the punch bowl before the party gets started. In a world of excess supply, the Fed’s responsibility is to take away the punch bowl only after the party gets a good buzz going — and then their greater responsibility is to take the car keys away from the guests who should not be driving home,” he wrote.

As a result of this shift, Ricchiuto said tighter labor markets, higher inflation levels and a lower dollar could become the new normal in coming years. Those economic conditions are good news for stock prices and credit spread, he said.

Benzinga’s Take: Many critics of the Federal Reserve’s aggressive COVID-19 stimulus spending in 2020 may be concerned about inflation. But the reality is that since the financial crisis in 2008, inflation levels have spent the majority of the time well below the Fed’s 2% target.

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