Post from First Trust Economics Blog

Brian S. Wesbury – Chief Economist
Robert Stein, CFA – Deputy Chief Economist 

June 9th, 2025

Back during the Financial Panic of 2008, clickbait

media kept screaming “Hyperinflation.” We consistently

pushed back against this theme, and argued inflation would

not accelerate. Yes, Quantitative Easing and zero percent

interest rates, which Ben Bernanke invented at the time,

massively increased the size of the Fed’s balance sheet and

boosted cash deposits and reserves at banks as the Fed

printed money to buy debt – Treasury bonds, mortgages

and other assets.

So why didn’t the QE of 2008-2015 cause inflation?

Because mark-to-market accounting destroyed capital

faster than the Fed or Treasury (remember TARP) could

boost it. At the same time, regulators significantly lifted

both the capital and liquidity ratios banks were required to

hold. The result: M2 grew at an average rate of 6% per year

during the crisis, about the same rate as it did before.

This all changed during COVID. The Fed reduced

liquidity rules and the Treasury enlisted banks in issuing

direct tax rebates, making PPP loans, and distributing

unemployment benefits, which caused M2 to surge. It was

one of the easiest forecasts we have ever made. When M2

surges, so does inflation. The CPI consumer price inflation

peaked at 9.0% in mid-2022, the highest in roughly forty

years.

The surge in M2 stopped in 2022. Today, M2 is only

0.5% above 2022 peak levels. Yes, M2 growth has picked

up in the past year, but it is still growing relatively slowly,

up 4.4% from a year ago, although up at 6.5% annual rate

in the past three months.

In the meantime, “real” (inflation-adjusted) short-term

rates have been hovering about 2.0% for the past two years

the highest, for the longest, since 2006-07.

It is because of this relative tightness in monetary

policy that inflation has slowed, as well. The annual

increase in the CPI has slowed to 2.3% as of April. Core

inflation, which excludes food and energy and which

peaked at 6.6%, is now down to a more respectable 2.8%.

There’s a similar story for “Super Core” inflation which

also excludes other goods as well as housing rents.

In the past three months, the CPI is up at only a 1.6%

annual rate while producer prices are down at a 1.2% rate.

This week we get updates on consumer and producer

prices and, as the table below shows, we expect the reports

to show inflation ran a little hotter in May than the three

prior months, but not really hot in an absolute sense.

This strikes many observers and investors as odd,

because the Trump Administration’s tariffs have been in

effect, although erratic, and should have been having an

impact by now. How can we have lower inflation and

higher tariffs at the same time?

Because, as we’ve been saying all along, the link

between tariffs and inflation is overrated. Yes, the specific

items that are tariffed might rise in price, but that means

less money left over to buy other goods and services, which

reduces those prices. Tariffs shuffle the deckchairs on the

inflation ship, not how high or low the ship sits in the water.

That’s up to the money supply.

None of this suggests the Fed won’t reverse course and

fully let down its guard. In spite of all the progress, we are

still above the Fed’s 2.0% inflation target. Inflation may

look gone, but boosting M2 and cutting interest rates

sharply could reignite the embers of inflation which are still

buried under the ashes from the COVID monetary fire.

We think the economy overall is ready for a modest

cut in rates. In fact, all interest rates across the yield curve

are finally above inflation. We do not think the interest rate

policies of the Fed were appropriate. Neither the 2008

Panic or COVID were caused by monetary policy, so

holding interest rates below inflation never made sense to

us. And, at this point, with the real federal funds rate at 2%

there is room for roughly two 25 basis point cuts. But the

Fed is wrongly focused on tariffs, so while rate cuts now

are warranted, the Fed is likely on hold until September.