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What is Reflation?

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Reflation is a period in which central banks and governments provide monetary and fiscal stimulus in order to spur economic activity and inflation. It often occurs during a recession, where you generally see deflation.

All this sounds like what’s happening now, right? That’s correct—and it’s becoming a consideration, for better or for worse, for investors right now.

Here’s the monetary policy aspect of reflation: The Federal Reserve lowers interest rates and expands the money supply by buying bonds, thus injecting cash into the banking system and economy.

And here’s the fiscal aspect: Congress appropriates funds to be allocated by several agencies like the Small Business Administration or the IRS. Cash grants and low interest loans are made, keeping households and small businesses liquid while revenues dry up.

All this is aimed at spurring spending, which is needed, because the last two readings of inflation have been negative, indicating weak demand.

What will likely follow? Inflation.

There are risks that inflation poses, but we’ll have to see if those risks come to fruition. And it’s important to note that the government and economic actors are largely willing to accept the possibility of meaningful inflation if it means saving the economy from depression.

The good news: inflation is often reflective of strong economic demand. Demand-sensitive stocks like consumer discretionaries, industrials, materials and energy may outperform. As interest rates rise, banks may do so too

The bad news: If inflation runs too hot, too fast, and if interest rates spike too high, stocks could spiral. The economy and the market still need interest rates to remain low. This could lead to a correction in stocks, but remember that the Fed could lower rates again in that case.

To see how to capture value in this environment, watch the quick video above. 

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