Why is this process inflationary? In what point the FED use the printing machine? "Instead, the Fed’s increased lending to the financial system over the last two weeks (+$325 billion) has been matched by an increase in the volume of deposits the commercial banks are hold with the Fed (+$331 billion). In other words, the Fed is now lending to the banks, which are now lending the funds back to the central bank. The Fed is no longer supplying just narrow liquidity needed to enable the market to function. It is now supplying excess funds (more than the banks need) which are being recycled back into the central bank.
The Fed is becoming the lender of only resort via this process. The process is not inflationary right now, but when the economy recovers it may very well turn out to be inflationary. But I’m not holding my breath. The Fed’s lending is being dwarfed by debt default/redemption. As long as this is the case, the inflation argument is dead.
^ Interesting point.
this chart will make most of you throw up… http://research.stlouisfed.org/fred2/series/MULT?&cid=24 velocity of money is at 1. 1!!! That means every dollar changes hands once per year at this point. if you understand quantity theory of money, inflation is completely out of the question, until this get above 1.5 at least and to boost the system to where it would be inflationary, this would have to rebound stronger than any metric ever in the history of man. we have deflation, we will continue to have deflation. V = 1 is disgusting in a world with our speed of money transfer.
I studied velocity of money quite a bit in school as an economics major. Was never put it in the context of real world though so I’m not too sure what a normal velocity is, although V=1.1 right now does sound real low. Anyone know what a normal velocity is in a developed country?
Very interesting chart…1.1 seems insane low.
The reason why you don’t put it into context is b/c no one really uses MV=PT as a formal equation. Also, that multiplier is the relationship between M1 and monetary base. It isn’t sick or disgusting by itself, just a result of the fact that the Fed is paying interest on excess reserves. As for the explanation, I don’t think it has been done well yet. First, inflation is fundamentally caused by an expansion of money and credit. If you give banks $1bn and then mark $1bn in reserves on the Fed balance sheet that the bank just leaves there and doesn’t lend out, then no new money is created. Therefore there is no inflation. Second, if the Fed makes an intervention that changes the composition of its balance sheet (like the CP point made above) without changing its size, the increase in money is sterilized and no new money is created. Third, there is a fundamental difference between the Fed’s QE and the Japanese QE. In Japan the purpose was to increase excess reserves to force the banks to lend. In the U.S. the focus has been balance sheet transformation to improve liquidity. In Japan, the process was inflationary when banks took the money into the economy. In the U.S., they changed the balance sheet (not inflationary, point 2), but then banks didn’t loan out the money (point 1), so it isn’t inflationary. If banks loan out of the money, it will be inflationary. This is why the Fed will likely need to mop up liquidity (by sterilizing) in late 2009 or 2010 to avoid problems with the inflationary consequences of the QE program.