EconoMonitor

The Wilder View

All of the buzzwords in one post: quantitative easing, inflation and printing money

`
I have received many emails from readers that are concerned about current Fed policy. In this post, I will address the following issues: what is quantitative easing; is the Fed printing money; and finally, will the Fed’s massive liquidity injections lead to inflation.

Quantitative easing (QE) by the Fed has begun. But before we can address the Fed’s QE strategy, we must get one thing straight. First, a QE policy is not a zero interest rate policy (ZIRP). The federal funds target is currently 1%, and although the Fed has initiated a QE strategy, it has not declared ZIRP…yet. The next scheduled meeting is December 15-16, where the Fed may very well set the policy rate equal to 0%.Without explicitly setting the federal funds target to 0%, the Fed is currently engaging in another non-traditional policy, quantitative easing (QE). Under a QE policy, the Fed increases bank reserves beyond levels consistent with ZIRP (technical definition according to Bernanke, Reinhart, and Sack). QE implies that the Fed no longer targets an interest rate.
The flood gates are open. The Fed is injecting the banking system with shiny new reserves (liquidity) and is no longer using open market operations to keep the effective federal funds rate – the overnight interbank loan rate – close to its target, currently 1%. In laymen’s terms, the Fed is printing money under the QE policy; the idea of the Fed printing money has clearly caused some confusion for readers. Printing money is a pejorative term that is often associated with inflation, or worse, hyperinflation. In normal times, a QE strategy would certainly result in newly available money, but we are not in normal times.
The Fed is not printing money, rather it is printing high powered money, where high powered money is the monetary base (reserves).What is the difference between money and high powered money? Money is a function of two things
  1. The monetary base, which equals bank reserves plus currency in circulation
  2. The money multiplier, or how quickly the base switches hands in a fractional reserve banking system (for a discussion of money creation, see this wiki article).

The Fed is raising the monetary base through its QE policy and increasing its balance sheet (credit extended to the banking system) from $884 billion on August 28 to $2.1 trillion on November 28. The Fed simply creates new monetary base (reserves) out of thin air; hence, the printing money connotation.

`

bank_reserves_chart.png

However, banks are hoarding the new base in the form of excess reserves, and lending has slowed significantly relative to the size of the new reserve base. Therefore, the money multiplier is collapsing.

` money_multiplier_chart.png

Will the Fed’s QE strategy lead to inflation? In the short-term, no. The money multiplier is falling because the economy is in a nasty recession alongside a serious credit crisis. In this environment, the surge of high powered money will not cause prices to rise.

Prices can drop in a recession (deflation) because the demand for goods and services falls with rising unemployment and declining income. But the 2008 recession is accompanied (or partially caused) by a credit crisis that induces banks to hoard the new base as excess reserves; this adds to the deflationary pressures. If deflation were to become embedded into consumer and firm expectations, then the macroeconomy could be facing a severe problem. So for now, and until the economy emerges from its recession, QE will not lead to inflation.

But what happens when the economy rebounds? Inflation becomes a serious risk if the Fed does not extract the high powered money. If the Fed gets it wrong, or its timing is off, then the money supply will rise quickly as banks start to lend more freely, and inflation results.

In the US’ case, I see the Fed getting it wrong as a serious risk to price stability (rising inflation). American consumers are not savers and love to spend; and although some suggest that the American saving behavior has changed, the evidence is far from concrete. Unless saving rises permanently – the economy transitions to a world where consumption is less than 70% of GDP – consumers will be more than happy to swoop up the new bank lending and spend that new easy money.


Originally published at the News N Economics blog and reproduced here with the author’s permission.

51 Responses to “All of the buzzwords in one post: quantitative easing, inflation and printing money”

mike ..AustraliaNovember 30th, 2008 at 5:09 pm

Fantastic to see that more articles about this subject of “frational reserve”, “high powered money” and the like are being explained in this timely way……..This article is the absolute best i have seen so far.Informative and not coloured with emotion in a really refreshingly composed way…..A delight to read.Since i consider myself a student, i want to have the best and clearest material about this almost esoteric aspect of money and its workings…Thankyou kindly for your good work!!

kumarFebruary 6th, 2009 at 12:37 pm

nice article…if you could relate this analysis to the “velocity” of the money as well, maybe it will help understand the topic better…

RickApril 1st, 2009 at 9:54 pm

Well written article that addresses part of the looming problems. Would be nice to have a new version with explanations on what one should do now if one believes in this scenario. If inflation is looming in 6 months, what should I do now?

chad's blogMay 30th, 2011 at 10:22 am

This one is an inspiration personally to uncover out much more associated to this subject. I must confess your data extended my sentiments as well as I am going to proper now take your feed to remain up to date on every coming blog posts you might probably create. You are worthy of thanks for a job completely done!

Damaris LarmonMay 31st, 2011 at 3:41 am

Amazing article. I was checking continuously this blog and I am impressed! Very helpful information specially the last part. I care for such info a lot. I was looking for this particular info for a very long time. Thank you and good luck.

blu356ble765May 31st, 2011 at 5:07 am

Oh my goodness! an incredible article dude. Thank you Nonetheless I’m experiencing situation with ur rss . Don’t know why Unable to subscribe to it. Is there anybody getting an identical rss downside? Anyone who knows kindly respond. Thnkx

reported reportMay 31st, 2011 at 3:52 pm

We are a group of volunteers and opening a new scheme in our community. Your website offered us with valuable information to work on. You’ve done an impressive job and our whole community is going to be thankful to you.

Claudio KeirJune 1st, 2011 at 12:13 am

I’d have to check with you here. Which isn’t something I usually do! I get pleasure from reading a post that will make folks feel. Also, thanks for allowing me to comment!

gpswatchJune 2nd, 2011 at 7:33 am

Various nice things brought up listed here. For certain i will lesemarke are available lower back for many more. Best wishes

שיווק אתריםJune 2nd, 2011 at 9:59 am

היי רציתי להציג על אתר אינטרנט על קידום אתרים בגוגל. באתר האינטרנט ניתןלקרא בטיפים על קידום אתרים בגוגל.

נטיה מיניתJune 2nd, 2011 at 8:51 pm

היי אני רוצה להמליץ לכם על פסיכולוג קליני אשר מעניק שירותי ייעוץ וטיפולים פסיכולוגיים באיזור המרכז

רכביםJune 9th, 2011 at 1:13 am

היי אני רוצה להמליץ לכם על חברה בתחום מכירת רכבים המתמחה בשרותי טרייד אין לציי רכב ולקוחות פרטיים . באתר, מידע רב המלווה בתמונות מכירת הרכבים ורשימה המתעדכנת באופן שוטף עם הרכבים הנמצאים במקום ומיועדים למכירה.

KACHELJune 9th, 2011 at 3:08 am

This is so good to see. We have do more things like this for the military families. They are protecting us and we need to support them in this way

ondergoed winkelJune 9th, 2011 at 1:41 pm

Its not the case that reader must be completely agreed with author’s views about article. So this is what happened with me, anyways its a good effort, I appreciate it. Thanks

Philips LED light bulbsJune 9th, 2011 at 3:34 pm

Today, I went to the beach front with my children. I found a sea shell and gave it to my 4 year old daughter and said “You can hear the ocean if you put this to your ear.” She placed the shell to her ear and screamed. There was a hermit crab inside and it pinched her ear. She never wants to go back! LoL I know this is totally off topic but I had to tell someone!

EvelyneJune 9th, 2011 at 7:34 pm

I found your site thanks a Google search. You have done a fine work. And it’s really nice to read you. I’ll definitely be back! 🙂

meet modelsJune 9th, 2011 at 8:58 pm

Hey clever points.. now why didn’t i think of these? Off topic slightly, is that this web page pattern merely from an bizarre installation or else do you use a custom-made template. I exploit a webpage i’m seeking to improve and properly the visuals is probably going one of many key things to complete on my list.

Forrest MendelJune 10th, 2011 at 8:38 pm

This webpage has therefore plenty excellent info on it, I verify on it everyday. I want alternative websites spent the maximum amount work as this one does generating facts legible to readers like myself. i like to recommend this page to all of my facebook friends. This webpage will make some massive passive profit i’m positive. I hope my web site does in addition to this one, it refers to jewelry shoppers houston

power mixersJune 10th, 2011 at 8:41 pm

Have you ever thought about including a little bit more than just your articles? I mean, what you say is important and everything. Nevertheless just imagine if you added some great pictures or video clips to give your posts more, “pop”! Your content is excellent but with images and clips, this website could certainly be one of the best in its field. Fantastic blog!

Sasha GrayJune 11th, 2011 at 4:02 am

You lost me, friend. Come on, man, I imagine I am what youre saying. I’m sure what you’re saying, but you just seem to have forgotten that might be other sorts of folks inside the world who view this issue for which it can be and will perhaps not trust you. You will be turning away numerous folks that was lovers of the website.

solid steel shipping binsJune 11th, 2011 at 12:09 pm

Ben WanP.S. Your blog is awesome.Ben Wan@Wordpress Technical Support recently posted..How to Get Highly Targeted Traffic through Social Bookmarking

stop goutJune 11th, 2011 at 3:52 pm

Throughout the grand scheme of things you secure a B- with regard to hard work. Where you actually lost us ended up being in your particulars. As it is said, details make or break the argument.. And it couldn’t be more accurate here. Having said that, let me inform you what exactly did deliver the results. Your writing is quite persuasive and this is possibly the reason why I am taking an effort in order to opine. I do not really make it a regular habit of doing that. 2nd, while I can easily notice a leaps in logic you make, I am not necessarily sure of exactly how you seem to connect your ideas which inturn help to make your conclusion. For now I shall subscribe to your issue however wish in the future you actually link your dots better.

Antique FridgesJune 12th, 2011 at 4:29 am

Hello this is a wonderful article. I’m going to email this to my associates. I came on this while exploring on bing I’ll be sure to come back. thanks for sharing.

backup to cloudJune 13th, 2011 at 3:00 am

Excellent issues?I might notice that as somebody who in point of fact doesn’t write on blogs a lot (actually, this may be my first publish), I don’t think the term ‘lurker’ may be very turning into to a non-posting reader. It’s not your fault in the slightest degree , however in all probability the blogosphere could get a hold of a greater, non-creepy title for the 90% folks that revel in reading the content material .

fabrica de bolsasJune 13th, 2011 at 2:51 pm

Excellent points?I might be aware that as any person who actually doesn’t write on blogs so much (in fact, this may be my first post), I don’t think the term ‘lurker’ may be very changing into to a non-posting reader. It’s not your fault the least bit , however most likely the blogosphere may just come up with a better, non-creepy name for the 90% people that revel in studying the content .

Baltic Amber Jewelry StoreJune 13th, 2011 at 6:45 pm

Hey I am so glad I found your site, I really found you by mistake, while I was browsing on Google for something else, Regardless I am here now and would just like to say thanks for a fantastic post and a all round entertaining blog (I also love the theme/design), I don’t have time to read it all at the minute but I have bookmarked it and also added your RSS feeds, so when I have time I will be back to read much more, Please do keep up the fantastic job.

StephenFJune 14th, 2011 at 8:41 am

Aw, this was a really nice post. In thought I want to put in writing like this additionally – taking time and precise effort to make an excellent article… but what can I say… I procrastinate alot and not at all appear to get something done.

Leave a Response