Quantitative Easing, Version 2.0

Per the FOMC announcement:

To help support the economic recovery in a context of price stability, the Committee will keep constant the Federal Reserve’s holdings of securities at their current level by reinvesting principal payments from agency debt and agency mortgage-backed securities in longer-term Treasury securities. The Committee will continue to roll over the Federal Reserve’s holdings of Treasury securities as they mature.

Here, we see an attempt by the Federal Reserve to prevent price deflation. Whether or not you believe price deflation will occur (I would wager that the readers of this website tend to view price inflation as the likely outcome), this particular move is inflationary as the Federal Reserve has not committed to reducing the size of its balance sheet.

Many intelligent people (e.g., Mish) are forecasting that price deflation will occur in the short-term. I tend to agree with Mish (in regards to the short-term). As noted in one of the Mises Daily articles for today:

After the crisis arrives and the depression begins, various secondary developments often occur. In particular, for reasons that will be discussed further below, the crisis is often marked not only by a halt to credit expansion, but by an actual deflation — a contraction in the supply of money. The deflation causes a further decline in prices. Any increase in the demand for money will speed up adjustment to the lower prices. Furthermore, when deflation takes place first on the loan market, i.e., as credit contraction by the banks — and this is almost always the case — this will have the beneficial effect of speeding up the depression-adjustment process.

The above quotation is courtesy of Murray Rothbard’s book: Man, Economy, & State.

A credit contraction is precisely what we are witnessing (Mish has pointed this out many times):

Total Consumer Credit Outstanding

In my opinion, the question we should be asking ourselves is which is likely to prevail.

Oftentimes, people point to graphs of the monetary base to argue that price inflation will occur:

Monetary Base (M0)

That is certainly a valid concern; however, I think it is somewhat of a faulty argument (with respect to the short-term). The increase in the monetary base shown above is accounted for by the increase in excess reserves held by the banking system:

Excess Reserves of the Banking System

These excess reserves are being held at the Federal Reserve and are currently earning a paltry amount of interest. For the most part, banks are unwilling to lend (unless if it is to the government) and consumers are unwilling to take out loans. Essentially, this money has not made its way into the economy.

I would recommend heading to Mish’s website to read more about the argument that price deflation will occur. He is very knowledgeable.

There are certainly arguments for both cases. What do y’all think?

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