Why Inflation Is Not in Double Digits Yet
March 31, 2011
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A lot of people have been wondering how inflation is not in the double digits right now considering all of the quantitive easing (QE) that the Fed has been engaging in. There are a few reasons for that, but first let’s have a look at what the Fed has been actually doing in this quantitative easing program.
Since the beginning of the crisis, the Fed has increased its balance sheet by $1.5 trillion. What has the Fed bought with the $1.5 trillion? Well, the Fed mostly bought treasury bonds, Freddie Mac (FMCC.OB) Fannie Mae (FNMA.OB) debt, and mortgage backed securities. The Fed, via open market operations, steps into the market and buys those securities. Since the inception of QE, the Fed has been buying mainly treasury bonds.
Now, because we live under a fractional reserve system, the commercial banks can pyramid loans on top of the money that was injected by the Fed by a factor of ten (the reserve ratio is 10 percent). Below, you can see the monetary base and how the Fed has increased its balance sheet by $1.5 trillion since the crisis began.
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That being said, the main reason the U.S. is not suffering from double digit inflation (though it’s pretty close to it) is that the banks have not been lending the money out. As is evident from the chart below, the commercial banks have been contracting their loans. There are two main reasons the commercial banks are reluctant to lend out the money.
First, their balance sheets have not entirely recovered. Second, the banks are afraid to lend the money out because they don’t feel secure enough that the borrower will pay them the money back.
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Business loans have been contracting too.
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When the commercial banks' balance sheets will be sufficiently healed and will feel more secure that borrowers can repay, or that the declining dollars that they hold will burn a hole in their balance sheets, they will start providing more and more loans. When that happens, it can be expected that inflation will really start to pick up as the money velocity increases.
Another fact which supports the argument that even higher inflation can be expected in the future is that the federal government is about to provide business loans directly to small businesses in order to stimulate the economy. The government will sponsor these loans by issuing even more bonds which the Fed will buy with money they printed out of thin air, and thus, the money supply will grow. When small businesses will start spending the money in order to buy equipment, hire employees, and so on, the money will start rippling through the economy causing inflation to go sky high.
In conclusion, though inflation is already high, (according to some estimates, it’s running about 8 percent), even higher inflation can be expected.
Since the beginning of the crisis, the Fed has increased its balance sheet by $1.5 trillion. What has the Fed bought with the $1.5 trillion? Well, the Fed mostly bought treasury bonds, Freddie Mac (FMCC.OB) Fannie Mae (FNMA.OB) debt, and mortgage backed securities. The Fed, via open market operations, steps into the market and buys those securities. Since the inception of QE, the Fed has been buying mainly treasury bonds.
Now, because we live under a fractional reserve system, the commercial banks can pyramid loans on top of the money that was injected by the Fed by a factor of ten (the reserve ratio is 10 percent). Below, you can see the monetary base and how the Fed has increased its balance sheet by $1.5 trillion since the crisis began.
.
.
That being said, the main reason the U.S. is not suffering from double digit inflation (though it’s pretty close to it) is that the banks have not been lending the money out. As is evident from the chart below, the commercial banks have been contracting their loans. There are two main reasons the commercial banks are reluctant to lend out the money.
First, their balance sheets have not entirely recovered. Second, the banks are afraid to lend the money out because they don’t feel secure enough that the borrower will pay them the money back.
.
Business loans have been contracting too.
.
.
When the commercial banks' balance sheets will be sufficiently healed and will feel more secure that borrowers can repay, or that the declining dollars that they hold will burn a hole in their balance sheets, they will start providing more and more loans. When that happens, it can be expected that inflation will really start to pick up as the money velocity increases.
Another fact which supports the argument that even higher inflation can be expected in the future is that the federal government is about to provide business loans directly to small businesses in order to stimulate the economy. The government will sponsor these loans by issuing even more bonds which the Fed will buy with money they printed out of thin air, and thus, the money supply will grow. When small businesses will start spending the money in order to buy equipment, hire employees, and so on, the money will start rippling through the economy causing inflation to go sky high.
In conclusion, though inflation is already high, (according to some estimates, it’s running about 8 percent), even higher inflation can be expected.
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