The Conundrum of Low Inflation Explained?
The conundrum of a low-growth, low-inflation environment combined with expanding, voluminous central-bank balance sheets has many scratching their heads. A recent stab at an explanation was given by Martin Feldstein, asking “Why is US inflation so low?”
Since 2008, Feldstein writes, the Fed has greatly expanded the money supply via its balance sheet, and yet all that time inflation, as measured by the Consumer Price Index, has remained at 1.5%. “The historical record shows that rapid monetary growth does fuel high inflation,” he says. “That was very clear during Germany’s hyperinflation in the 1920s and Latin America’s in the 1980s. But even more moderate shifts in America’s monetary growth rate have translated into corresponding shifts in the rate of inflation. In the 1970s, US money supply grew at an average annual rate of 9.6%, the highest rate in the previous half-century; inflation averaged 7.4%, also a half-century high. In the 1990’s, annual monetary growth averaged only 3.9%, and the average inflation rate was just 2.9%.”
Which is what makes the current disinflationary environment seem “so puzzling.”
Contrary to the reigning theories, which see central bank money creation as translating directly into money in circulation (which fear is what drove gold prices so high – and which, not having materialized, subsequently has precipitated gold’s decline), Feldstein denies the direct connection between Fed expansion and money-supply expansion. “The puzzle disappears when we recognize that quantitative easing is not the same thing as ‘printing money’ or, more accurately, increasing the stock of money.” Feldstein notes that it is not money that is being printed, but deposits that are being supplemented. These deposits are held by member banks. They are liabilities on the Fed’s balance sheet, corresponding to the Fed’s asset purchases.
And this has not translated into money growth at the consumer level, because, Feldstein argues, the Fed is paying interest on “excess reserves,” something which prior to 2008 it did not do. This has led member banks to maintain excess reserves, and indeed, these reserves have increased from less than $2 billion to $1.8 trillion. Feldstein says that this is money that member banks otherwise would have to lend out in order to make money from, but now, with the Fed’s interest payments, they don’t have to. They can just lean back and let the Fed’s interest payments roll in.
But this is to misconstrue the way the banking system functions. We have what is called a fractional-reserve system (something that I have elsewhere argued is a misnomer, but that is not relevant to the question at hand), and according to that system, a bank is allowed to lend out a multiple of the reserves it holds at the reserve bank. Reserves at the central bank, in our system, allow lending, rather than restrict it. Money held at the central bank is not money that otherwise would be lent out, but money that allows for even more money to be lent, indeed a multiple thereof. Banks, in fact, “create” that money, precisely through the “fractional-reserve” mechanism. So that “excess” reserves do not inhibit lending but allow it. The fact that they are “excess” is simply a function of a bank’s decision not to lend out as much money as it otherwise might.
It may be that, because of the change in Fed policy, banks now have more of an incentive to hold “excess” reserves than they used to. But it seems far-fetched that such an interest payment could outweigh the potential of interest payments on a multiple of that amount, which is what lending against those reserves would provide.
Alas, one must look further to find an explanation to this provocative conundrum.
Like John Carter, Ruben Alvarado is an expatriate Virginian living on another planet – not Mars, but the Netherlands. A graduate of the forestry school at Virginia Tech, Alvarado was a Peace Corps volunteer before moving to the Netherlands. There he began work as a translator for an investment news agency. He has since branched out into writing and publishing, and is the proprietor of WordBridge Publishing, a publisher of books emphasizing Christianity and the common law. His most recent book is “Follow the Money: The Money Trail through History,” which narrates the various forms and stages money has taken through the ages, and highlights why the tale is so important. Alvarado lives in Aalten, the Netherlands, with his wife and three children.
Trending Now on Affluent Christian Investor
Sorry. No data so far.
The Affluent Mix
The Era Of No Consequences January 14, 2021 | Frank Vernuccio

Income And Well-Being January 14, 2021 | Jim Huntzinger

How Companies Pay Shareholders: Buybacks Don’t Subtract From Wages... January 14, 2021 | Jerry Bowyer

Taper Nervous Breakdown January 14, 2021 | Michael Pento

China, Democrats, And Donald Trump January 8, 2021 | Frank Vernuccio

Biochemical Engineer Ivor Cummins Discussing “The Rosetta Stone Of Modern ... January 7, 2021 | Jerry Bowyer

Hillbilly Elegy Economics Lesson: Culture Matters... January 7, 2021 | Roger McKinney

Take The Under On 2021 GDP January 7, 2021 | Michael Pento

How Companies Pay Shareholders: Buybacks Are Not A Giveaway... January 7, 2021 | Jerry Bowyer

The History Of Income Inequality And Popping Economic Bubbles... January 7, 2021 | Jim Huntzinger

Diseases Of Modernity: What Do They Have In Common?... December 22, 2020 | Jerry Bowyer

Mobocracy December 22, 2020 | Frank Vernuccio

Beware Market Land Mines: Stimulus, Vaccine Failure, Interest Rates... December 22, 2020 | Michael Pento

Following Classical Economics December 22, 2020 | Jim Huntzinger

What Prostate Cancer Taught Me About Our Fiscal And Physical Health Code Blue... December 22, 2020 | Kevin Cullis

The War Of The Worlds December 22, 2020 | Terry Applegate

Cuomo’s Partisan Authoritarianism Struck Down By SCOTUS... December 15, 2020 | Frank Vernuccio

Socialism: The Road-To-Hell Paving Company... December 15, 2020 | Roger McKinney

Amazon And The Los Angeles Lakers Wreck The Wage-Stagnation Narrative... December 15, 2020 | John Tamny

Capital Abounds, And It Needs A Place To Go... December 15, 2020 | David Bahnsen

How Companies Pay Shareholders: Buybacks Are Not A Giveaway... December 15, 2020 | Jerry Bowyer

Signs That Biden Will Be Soft On Iran December 10, 2020 | Frank Vernuccio

Join the conversation!
We have no tolerance for comments containing violence, racism, vulgarity, profanity, all caps, or discourteous behavior. Thank you for partnering with us to maintain a courteous and useful public environment where we can engage in reasonable discourse.