One of the surprising outcomes of the Great Recession was the lack of inflation that followed. Of course, this was contrary to expectations at the time as many prominent investors were positioning themselves for a resurgence in inflation. One major counterweight to these views was the bond market which continued to trade as if inflation was unlikely.

The inflation argument made total sense as interest rates were at record lows, the federal government was running record deficits, and the Federal Reserve had expanded its balance sheet by trillions of dollars. After financial markets bottomed in March 2009, there was a powerful rally in all types of assets that had all the indicators of inflation coming back into the system such as stocks (SPY  ) gaining, commodities (DBC  ) bouncing back, gold (GLD  ) hitting record highs, and interest rates rising.

However in hindsight, it's clear that the rally was reflationary - reversion to the mean from the last six to nine months of deflation - rather than inflationary. This is evident in a number of assets like gold giving up the bulk of its gains, Treasuries (TLT  ) continuing to rally, and strength in the US dollar (UUP  ). All of these developments are antithetical to an inflationary boom.

Key Differences

A major lesson from this experience is that for inflation to take hold, money has to go from the financial economy to the real economy. By increasing reserves and lowering interest rates, the Federal Reserve eliminated the possibility of banking failures, but it didn't guarantee that people or businesses would be eager to borrow money or banks would lend it. This is another indication that people's emotions or animal spirits have a bigger impact on risk-taking than the price of money.

There were other major deflationary forces that overwhelmed inflation. These included high levels of excess labor. For companies, there was no reason to raise wages. For inflation to take hold, there has to be a reinforcing feedback loop between wages and prices. Companies have to raise wages to retain and attract workers and then raise prices to maintain margins.

Another deflationary force was austerity for state and local governments. The Great Recession resulted in a plunge in tax revenue which forced state and local governments to lay off employees and cut spending which negated part of the federal government's efforts and hampered the recovery.

Today's Situation

It's remarkable that many of the early conditions of 2008 are being replicated today. Central banks are pumping money to support various credit markets. The federal government is running fiscal deficits. Interest rates are also at record lows.

Whether inflation emerges this time depends on what lessons policymakers have learned from the previous experience. It seems the Fed has learned, as last time it paid interest on reserves that banks held on deposit at the Fed which incentivized them to do nothing and earn a risk-free return. This time, the Fed and Treasury were paying banks to make loans.

However, it's concerning that policymakers are so far unwilling to give support to state and local governments as they have for workers and businesses. These governments going bankrupt, cutting spending, or laying off workers in the midst of a recession would only make things worse at a perilous time and undercut other efforts.

Finally, wage growth is impossible with massive unemployment. But, the unemployment situation will only be solved with concrete progress in terms of testing and tracing that gives people the confidence to resume normal activities.