I was talking to some of my more co-workers today at the insurance company I just started working at. we were talking about interest rates and inflation. They told me historically inflation averages 3.2% a year. The last 5 years its been 1.something (I cant remember what he said). I told him thats impossible since the Fed pumped more money into our economy (1.2 trillion) in two weeks back in 2008 than in the entire history of the Fed previous. their reply “it’s coming very soon.” If it hasn’t hit yet, then when it does won’t it be an epic nightmare (like 1923 germany hyperinflation kind of nightmare)? Because the Fed has inflated slowly over time and consistently, doesn’t this mean we feel the price change very slowly which makes it less noticeable to the average consumer? But because SO MUCH MONEY was pumped into the economy in such a short period of time (2 weeks) we are going to feel the pain of that in a very short period of time as well? If in the entire history of the Fed (founded in 1933, i believe) and we had a total of say 1 trillion dollars of inflation but it was spread out over the course of 75 years (2008), and since more than that was pumped in in a matter of weeks, prices will skyrocket almost overnight, right?
The Fed doesn’t actually increase the money supply, the banks create new money through loans. It is assumed, incorrectly, that banks will lend the newly created reserves at a multiplier of about 10-1. That false assumption is why hyper inflationistas are going to continue to look like fools.
A combination of credit destruction, insolvent zombie banks, and an over leveraged public, make it virtually impossible for credit, and therefore new money to be created. Until banks increase the volume of loans, deflation not inflation, will be the main concern. When the velocity of money increases the Fed will be fighting inflation, as they try to sop up the excess liquidity. But, until that time, we are essentially in a zero bound liquidity trap.
On a side note: Inflation in highly demanded goods, i.e. food, energy, clothing will remain a problem. Stagflation, biflation, whatever you want to call it, lower wages and higher cost of living = lower living standards.
- “Sop up excess liquidity?”
Sop up?
Like it’s some spilled coffee that needs to be sopped up.
- “…deflation, not inflation, will be the main concern.” “Although of course, food, energy, clothing, will remain a problem.”
Isn’t that contradictory?
- “The Fed doesn’t actually increase the money supply…”
Bernanke said on national television that it does indeed increase the money supply. He called it “printing money”.
- “…zero bound liquidity trap…”
From our good pal Wikipedia:
A liquidity trap is a situation described in Keynesian economics…Austrian School economists generally argue that a lack of investment during periods of low interest rates are the result of malinvestment and time preference instead of liquidity preference.[11][12] Most Austrian economists have rejected Keynes’ theory of liquidity preference altogether.
Just saying.
- cubfan, I suspect you are giving us a non-Austrian interpretation of things.
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The FOMC can expand and contract bank reserves by expanding or contracting their balance sheet. When bank lending increases, and the velocity of money picks up, the fed will sell assets in order to sop up the excess reserves. I believe the Bernank will have a harder time at this than he suspects, but that is beside the point. The Fed can and will sop up the extra reserves, i.e. liquidity, when lending and therefore inflation picks up.
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As Kyle Bass puts it " We will have deflation in the things we own and inflation in the things we need". Calling for bi-flation is not contradictory, I believe we are in a situation were massive credit destruction is unleashing deflationary forces across a wide swath of the economy. In response, central banks are trying to combat that by unleashing massive liquidity into the system. But injecting reserves into banks does not, by itself, create inflation, bank lending does.
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The Fed doesn’t create new money, they create reserves, banks create new money in the form of loans. Printing money is a euphemism that people use, but it isn’t entirely true. Bernankenstein has never printed a dollar in his life, he wants to drop it out of helicopters, but has never actually created a new dollar in the economy.
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Call it whatever you want, but the Fed is pushing on a string. Banks won’t lend the new reserves because they are insolvent zombies, they need time to “repair” their balance sheets, they do not have enough qualified debtors, and the public is unable and unwilling to take on more debt. Monetary policy is completely impotent at this point even though we are in the zero bound and have ZIRP in perpetuity.
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I’m giving you an interpretation of reality.