Monetary base, money supply, and inflation

Economics Economics Questions
1

I’m confused about the relationship, and role of the monetary base, the money supply, and inflation. I think there has been a change in the way these things interact with each other. Looking at a recent graph of the monetary base, that thing looks like a hockey stick. For years and decades, it was relatively flat, and then in the fall of 2008, it spiked skyward, drastically.

According to my best understanding, the monetary base grows, when the FED buys things, such as government bonds, and more recently, they buy other bonds from banks as well (toxic assets). Any of these acquisitions increases the monetary base, and in the process, it increases the money supply in the same direction, exponentially, which is why the monetary base has sometimes been referred to as “High Power Money”. I think the expansion of the over-all money supply is brought about by the workings of our fractional reserve banking system. As I understand it, it works like this: When the FED bought the bond, it paid for the purchase with money it created out of nothing, not even thin air! Whoever sold the bond to the FED, then deposits the proceeds in their own bank, and that new money deposit is the base for new loans, layered on top of new loans, bringing about an inflationary credit expansion.

Since the financial crisis, in the aftermath of the housing boom, I think the operation I explained above has ceased to operate in the same way. The FED is certainly doing its part, even more so, by buying bonds, scads of them, and even buying directly from the treasury, which they never used to do. The thing that has changed, from the way the whole process used to work, is that the banks are not lending the new money they acquire to businesses, and consumers like they used to. Why? And since they are not, exactly what are they doing with the money they acquire from the process of monetary base expansion?

If all this new money is not being used as before to create loans, which give rise to the wherewithal to create more loans, and so on as it goes, then the money supply does not grow exponentially, and inflation does not result. As a matter of fact, someone correct me if I’m wrong, but I think the growth rate of the money supply has remained quite calm. So, where is the source of inflation? If it is due to the artificially suppressed interest rates, how is it accomplishing a rise in inflation, if there is not a substantial increase in the amount of new loans???

2

Let me start by saying that you seem to have a sound basic understanding of what’s what. May I reccomend Hazlitt’s book on inflation for the fine points?

Because consumers are a bad risk. Perhaps businesses are as well, given the current state of taxes, regulations and unions, that prevent them from making a profit. In any case, once bitten twice shy.

In the meantime, the govt is giving the banks a much sweeter deal than any business can. It lends the banks at close to 0%, and the banks then turn right around and lend to the govt at 5%. And of course the govt wont default, because it has a printing press, unlike a risky business or consumer.

And that’s where all the money is going, to the good old US of A.

  1. First, AE says low interest and new loans do not in and of themselves cause price inflation. Because every dollar spent in one place cannot be spent on anything else. There have to be new dollars created which will then gobble up in many places, causing prices to rise.

  2. Price inflation does follow money printing overnight. it takes a while. Who knows how long. Take the inflation we are experiencing now in gold and commodities and to a nice extent in consumer prices. Is it a result of QE1 or QE2? At any rate I’ve seen Bob Wenzel say that the effects of QE2 have not yet hit the consumer.

Bottom line, the source is past money printing.