Is inflation coming?

Despite the fact that the monetary base has nearly doubled in the last year, we don’t seem to be suffering from obvious excess inflation…at least not yet. But is it coming? Bob Murphy argues today on that it clearly is, and new ideas for dealing with it, such as the Fed selling its own bonds to modulate the money supply as needed, will only make things worse:

Let’s say the Fed wants to drain $100 billion in reserves out of the banking system, in order to cool off rising prices. But it doesn’t want to sell off some of its assets on its balance sheet (like “toxic” mortgage-backed securities), so instead the Fed sells $100 billion worth of the brand new “Fed bonds,” …In the beginning, this will indeed solve the problem. When people in the private sector buy the Fed-issued bonds, they write checks on their banks and ultimately those banks see their reserves go down at the Fed. There is less money held by the public, and so prices don’t rise as quickly.

But what happens when the Fed bonds mature? For example, if the Fed sold a 12-month bond paying 1% interest, then after the year has passed our private sector buyers will hand over the securities and now their checking accounts will be credited with $101 billion. At that point, the economy would be in the same position as before, only worse: there would be an extra billion in newly created reserves (because of interest on the Fed debt).

Another interesting argument by Mike Shedlock about coming inflation was posted on the @TAC blog earlier this month:

I suspect that the deflationists are right in the short term: the annihilation of so much ledgerbook money should create a deflationary pressure. But the Fed is doing everything in its power to print its way out of deflation — which would actually be beneficial as a correction to the inflated real estate, stock, and other prices we’ve seen over the last 20-odd years — and into inflation. Shedlock argues that as long as the banks aren’t lending, we won’t see inflation, and Polleit notes that they have indeed massively increased their excess reserves (from $1.9 billion to $798.2 billion so far). Trouble is, eventually the banks will start loaning out that money again, which is when inflation explodes.

Read the rest here.

Published in

Post a comment