On December 16, 2008, the Federal Reserve cut its target for the shortest-term interest rate to nearly 0%. The Fed’s bold policy action was one of many aggressive steps taken to stabilize global financial markets and a U.S. economy that was in freefall. The Fed’s goals have been clear: prevent broad-based wage deflation, lower borrowing costs, rouse investors’ animal spirits, create incentives for risk-taking and, ultimately, investment in new ventures that would create new jobs, the engine of a self-sustaining recovery.
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Note: For an expanded look at Vanguard’s outlook for inflation—and an explanation of the data behind our analysis—read our interview with Joe Davis on vanguard.com.
As Vanguard’s chief economist, I’m often asked about inflation. And it’s an important topic. As the 1970s and early 1980s taught us, a persistent and unexpected run-up in inflation can significantly influence the economy, interest rates, and, by extension, the returns on stocks, bonds, and other investments.
Some of my friends are convinced that a return to the high inflation of the 1970s and early 1980s is inevitable. They point to the sharp rise in the Fed’s balance sheet (in addition to the temptation for governments to “inflate away” their national debt) as setting the stage for, at best, a return to 1970s-style inflation rates of 10% or more and, at worst, a significant crash in the U.S. dollar and stock market.
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I was at a garden party recently, on a beautiful Sunday afternoon in September, where talk centered around the economy, politics, favorite movies, and the latest in electronic gadgets. Yet one conversation that struck a particular chord with me was the “case for China.”
You’ve heard it repeated in various forms. The Chinese economy is booming, while the developed economies are in a funk. Chinese infrastructure is gleaming and new, while U.S. infrastructure is falling apart. Output from the Chinese economy will soon exceed U.S. output, signaling the end of American influence and prominence in the world. The argument is actually much broader and about emerging markets in general. The emerging economies are ascending, and the U.S. and other rich countries are washed up.
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When the stock market sells off, as it did in late July and early August, there is an inevitable surge in commentary on the riskiness of U.S. retirement accounts. The main worry is that retirement investors are taking on too much risk and that retirement assets should be invested in “safer” securities or programs.
From my perspective, many such criticisms seem unduly focused on the short run.
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Everyone who is not on vacation appears to be focused on the uncertainty created by the lack of a resolution to the most recent government funding crisis. I wish I could add some value with respect to the discussion of the “default” issue or, even better, predict what the final outcome will be. I can’t.
And of course my own views on the subject ultimately don’t matter much. In fact, they probably matter even less than the views of people we’re all watching on TV and reading in the press who are paid on the basis of how well they can attract and retain attention in the mainstream media.
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