Quantitative Consequences

Antony — September 1, 2011

Following the housing and financial collapse in 2008, the political and financial establishment engaged in extraordinary measures to stem the panic. Included in these measures was the creation of huge amounts of money by the Federal Reserve, called “Quantitative Easing”, increasing the Base Money supply from about $800 Billion to $2.8 Trillion.

So why hasn’t this cash infusion shown up in the form of massive price inflation? Part of the explanation is that large amounts have been soaked up in the reserve holdings of foreign central banks. The monetary inflation has also been offset by deleveraging to repair balance sheets in the private sector, both by firms and individuals. But the primary reason that the Base Money has not made its presence felt in the general economy is that most of it is being held as excess reserves on the banks’ balance sheets.

These excess reserves represent potential future inflation. If they are loaned out into the economy though the fractional reserve system, the effects will be felt as price inflation. How and where these effects will appear depends on how the institutions that control them choose to channel the money into the economy.

How and when will this happen? Austrian Economics teaches us that the future is unpredictable, since it is based on human action. But we can monitor the pace at which the reserves are being lent out. A good indicator of this is the M2 money supply figures.

The money created through Quantitative Easing has accumulated like snow pack perched at the top of a cliff. Will it be released in an inflationary avalanche? If we are lucky the buildup may melt away harmlessly in the warm glow of a sound and vibrant economy.  But if these first trickles are the tipping point in a runaway process, then watch out in the valley below.

Comments

Kyle says

This is a succinct and clear explanation of where legitimate inflation fears come from! That said, have you considered that the Fed’s payment of interest on the reserves banks hold with it is the reason we haven’t seen runaway inflation yet, and may not at all? Karl Smith explains the point clearly here:
http://modeledbehavior.com/2011/09/09/how-can-the-fed-avoid-hyper-inflation/

— September 9, 2011

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