Low inflation has become a mainstay of economic policies and financial markets over the last decade. It explains how central banks have been able to cut interest rates and buy up large amount of government bonds and why huge amounts of fiscal relief in response to Covid-19 can be spent without moving the inflation needle too much.
In this period of large-scale quantitative easing and expanding government debt, a new era of monetary policy has emerged – one in which deficits and debt burdens are allowed to run financed by central banks purchases. 
However, this continual debt monetisation is dangerous for long-term faith in developed market currencies and may have implications for the velocity of money – the rate at which money is exchanged in economies – in future generations.
While it stands to reason that there should be a short-term surge in inflation eventually, owing to pent-up consumer demand that has been building since last year, David Jane (pictured) – manager in the Premier Miton Investors macro-thematic, multi-asset team – does not think this will change the long-term inflationary outlook.
He explained: “I really don’t buy into the concept that there’s a change in the long-term trend of growth and inflation when you have an economy with such relatively low structural growth rates.”
He conceded that while bond yields are where they are because of central bank purchasing, that is another short-term feature.
“The reality is you can’t manipulate the bond market to that degree in the long-run,” he added. “They have to reflect the price.”
There’s a worry that a small surge in inflation would reveal the full cost of government debt and central bank liabilities, given that in the US, Britain, Japan and the eurozone, central bank balance sheets have risen by more than 20 per cent of their combined GDP since the crisis began.
“The question then becomes whether you can issue money forever and what this does to the theoretical relationship between bond yields and economic growth?” asked Jane.
Another theoretical relationship lies between the amount of government debt and how that affects the long-term growth of the economy.
“If you issue too much government debt, then [short-term] bold yields go higher because there’s no market for them,” said Jane.
“But there’s a crossing over point whereby issuing too much government debt sends [long-term] bond yields lower and then it becomes less attractive to invest in the real economy because the expectations are that it will contract over long periods of time and that’s where we’ve got to in Japan, Europe and the west generally.”
“There may not be the demand for the government debt that you would hope, but at the same time bond yields are truly reflecting the fact the government has crowded out the private sector,” he said.
There’s also an argument that governments could use a surge in inflation to reduce the real value of that long-term debt and ease the strain on balance sheets.
“We’ve moved into a new era of monetary policy,” said Premier Miton’s Jane. “The old way of looking at the world – wherein government debt is a burden on future generations which will have to be paid back by increasing taxation or inflation – is maybe redundant now.”
Indeed, in theory, if the government runs a deficit forever and their own central bank buys the debt, then that debt is continuously monetised.
“If that is the case, modern version of money printing, which always used to be inflationary in the long run is not proving to be inflationary in the short-term and if you can just issue debt, does it matter?” Jane asked.
Modern monetary theory would suggest that taxation is an optional policy tool rather than a funding mechanism, but if you can print money forever “then you only have to tax people as a social policy, not a fiscal policy”, said Jane.
“It’s reasonable to suggest that modern monetary theory and the massive deficits will ultimately lead to a lack of confidence in currency and that will ultimately lead to inflation in the real economy,” he noted.
The huge increase in the money supply over recent months has not led to rising inflation because money velocity has fallen in lockstep with the stagnating real economy.
Considering, though, that nearly one-fifth of all US dollars in existence have been created this year, what happens when the money velocity picks up?
“That money is sitting in consumers and company balance sheets and that’s causing the lack of structural growth at the moment,” the multi-asset manager said.
“Where you’re seeing it now is in real assets like gold and bitcoin, investors are adjusting their financial portfolios to represent the lack of confidence in currency, but it’s not leading to inflation in the traditional sense.”
While there appears to be a growing decline in the confidence in money – people are still hoarding it in anticipation of a return to normality later this year.
Jane explained that when money velocity picks up and the money goes from financial markets back into the real economy, that could prove to be headwind for financial markets.
“In the same way that it’s so easy to park excess cash in the stock market,” he finished. “At the margin you can imagine money pulling away from financial markets.”