Why inflation is so modest with zero interest rates and after Q1 and Q2?

Reply

Eugene Posted: Sat, Sep 15 2012 1:56 PM

rated by 0 users

Do you have explanation for this?

My own explanation (which might be bogus) is that government bonds are interchangeable with money, and when Bernanke printed money to buy bonds, he didn't in fact change the money supply, because bonds are part of the money supply. So banks now have one type of money (cash) instead of another type of money (bonds). So theoretically this shouldn't change much.

What do you think?

Reply

grant.w.underwood replied on Sat, Sep 15 2012 2:04 PM

rated by 0 users

because they can change the numbers up.  It doesnt matter, if they wanted it to read 10% inflation rate they could.  I think they have such low inflation rate (which they typically do) to give off the impression of GDP growth. 

Reply

Eugene replied on Sat, Sep 15 2012 2:09 PM

rated by 0 users

I'm not talking about CPI, but about the real inflation, which I think is quite modest, especially when compared with the huge amount of money printed.

What do you think about my explanation for this?

Reply

eliotn replied on Sat, Sep 15 2012 2:12 PM

rated by 0 users

"because they can change the numbers up.  It doesnt matter, if they wanted it to read 10% inflation rate they could.  I think they have such low inflation rate (which they typically do) to give off the impression of GDP growth."

Thats a good reason but there are other reasons for making inflation look artificially low.  Part of the reason is that many government payments are indexed to inflation.  Make the numbers lower and you don't have to pay as much.  This also helps business owners escape the yoke of unions, because unions often request that payment is indexed to inflation.  Making inflation look like 10% means the government has a 10% increase in some payments as opposed to 0% inflation.

Reply

grant.w.underwood replied on Sat, Sep 15 2012 2:17 PM

rated by 0 users

i doubt the people who own homes in socal or vegas think their inflation was modest.

The bubble busting brought down a lot of prices and lots of the inflation is going college tuition.  And inflation is (to use your terms) 'modest' because the bank is sitting on it.  They are holding onto historic high numbers.  Also companies are holding onto a ton of money because the future is so uncertain (elections playing a major part too).  If romney gets elected a lot of spending and the fed's inflation will hit faster.

Just a couple things that i see.

*edit addition - i dont think gas prices or food prices are modest increase in prices.  Dont know how related to inflation those prices are, but they are certaining shooting up.  Maybe it had something to do with not owning a car for the past 4 years or going to a grocery store for 4 years, but im in shock.

Reply

eliotn replied on Sat, Sep 15 2012 2:18 PM

rated by 0 users

"

I'm not talking about CPI, but about the real inflation, which I think is quite modest, especially when compared with the huge amount of money printed.

What do you think about my explanation for this?"

Yeah, you have to clarify what you mean by inflation, as there are several different definitions people have for it.  CPI is a valid definition, as well as increase in money supply.  The problem with trying to base inflation off of prices is that its fruitless, some prices can increase while others decrease, but this will affect different people differently, based on their preferences.

If you are talking about monetary inflation, keep in mind that whenever a bust/banking crisis occurs, it causes defaltion.  This happens as banks go insolvent, destroying the illusiory money created by fractional reserve banking.  So in that circumstance, even if money is being printed at a fast rate, it is also being destroyed by banks going insolvent.

Reply

HabbaBabba replied on Sat, Sep 15 2012 2:21 PM

rated by 0 users

Because banks aren't lending. The money isn't really entering the market place to any degree.

Reply

Eugene replied on Sat, Sep 15 2012 2:51 PM

rated by 0 users

I understand.

However why does it matter whether banks have government bonds or money? In both cases they can use this instruments to bid for stuff on the market and to raise prices. Now the banks are hoarding huge amount of money. But before that they hoarded huge amount of government bonds. So what's the difference?

Reply

Clayton replied on Sat, Sep 15 2012 3:07 PM

rated by 0 users

Bonds are not cash and they do not act like cash and are not substitutable - either legally or economically - for cash.

There are two reasons why US local inflation has not risen to the actual levels of money-printing the Fed has engaged in: 1) the Fed has ordered the commercial banks to keep much of this printed money on deposit with the Fed itself. This is part of Bernanke's theory that inflation itself is not necessarily required to accomplish policy goals, merely the credible threat of inflation. 2)

The US empire allows the Fed to induce the central banks of subservient nations to use the dollar as a reserve currency. This permits the Fed to "export inflation" onto those subservient nations. Hence, looking only at the US domestic money supply is misleading in calculating the real effect of Fed money printing. You have to count all those foreign reserves and their inflationary effect on the currencies they back. This has the effect of 'diluting' the inflation from the point-of-view of US residents.

Clayton -

Reply

Phi est aureum replied on Sat, Sep 15 2012 4:05 PM

rated by 0 users

+2 Clayton

#2 is a big one people often overlook. We export inflation/debt. In this sense, there is no trade deficit.

Reply

Esuric replied on Sat, Sep 15 2012 6:20 PM

rated by 0 users

The FED is paying interest on reserves, constricting velocity and therefore broader measures of the money supply. Your explanation is entirely incorrect. It is wrong. 

Reply

Kelvin Silva replied on Sat, Sep 15 2012 6:44 PM

rated by 0 users

I live in southern california.

750k for a townhome 3 bedroom 2 bath.

I went crazy when you can buy a mansion for that price elsewhere in the US.

Also if the government raises taxes, thereby taking more money out of the economy, doesnt that help to keep inflation low?

Reply

Phi est aureum replied on Sat, Sep 15 2012 6:50 PM

rated by 0 users

@Kelvin

Not necessarily, and most definitely not often.

Taxation could be used to combat inflation if the revenue were taken out of circulation, but it generally is not. The government doesn't tax to keep inflation in check, it taxes to spend. 

Taxation just leads to a misapplication of capital and resources. So there is inflation, and the politically connected institutions don't bear the brunt of it, those that are taxed and/or do not receive the new money do.

Reply

Kelvin Silva replied on Sat, Sep 15 2012 7:38 PM

rated by 0 users

Hmm i see.

Is there any instance where government taxed the citizens just to hold that money in a vault?

Reply

grant.w.underwood replied on Sat, Sep 15 2012 7:41 PM

rated by 0 users

im not sure i quite understand clayton's first point.  I'm assuming its along the lines of my point that the banks are just sitting on the money?

What policy is accomplished by 'keep[ing] much of this printed money on deposit with the fed'?  Is he saying its just a propaganda tool to fool the general public into thinking our economy is alright because banks have 'all this money'?

number 2 great point.

Reply

Esuric replied on Sat, Sep 15 2012 7:45 PM

rated by 0 users

This does raise an interesting issue though. The high-powered money that the FED has injected into the system is (a) earning interest and (b) held in reserves at the FED (related to point a). So is it really money? It's not intended to enter circulation and money does not earn a yield (though I guess deflation/inflation can be seen as a sort of yield). So if we conclude that it's not money, then the FED really has exchanged one type of security for another. 

Reply

eliotn replied on Sat, Sep 15 2012 8:16 PM

rated by 0 users

+1 Clayton

Reply

Clayton replied on Sun, Sep 16 2012 1:10 PM

rated by 0 users

What policy is accomplished by 'keep[ing] much of this printed money on deposit with the fed'?

Bernanke has clearly stated his view that, for the purposes of ending/combatting recession, all that is needed is the credible threat of inflation to drive investors and consumers out to the market to buy stuff, which is supposed to be the whole purpose of the Fed during recessions. Those commercial bank reserves deposited with the Fed are the equivalent of a standing army with respect to war - they are ready to be mobilized (dispersed into the market) at a moment's notice. Investors are well aware of this and they understand that this shifts the risk/reward ratio of holding cash versus investments.

Clayton -

Reply

Eugene replied on Sun, Sep 16 2012 1:20 PM

rated by 0 users

From what I see investors hesitate to spend on capital, and banks hesitate to lend because they all expect rampant inflation. Do you think its the first time the Fed didn't manage to fool the population? Very few people are being fooled into taking or giving loans and into expanding when the outlook for the economy and especially the inflation is so omnious. So maybe after 100 years of inflation people started to realize that when the government encourages spending and taking risks, you should better buy gold instead or invest in real estate and not take the bait?

Reply

Esuric replied on Sun, Sep 16 2012 1:33 PM

rated by 0 users

Clayton,

It also has the effect of increasing bank capitalization (indirectly) and liquidity ratio's (directly), therefore reducing the degree of risk on bank balance sheets. This increases confidence in those banks (along with the 'stress-tests') and restores confidence in our financial system (reassures the average investor that it is structurally sound). 

Reply

econpunk replied on Sun, Sep 16 2012 2:28 PM

rated by 0 users

Most of the money the Fed printed during QE 1 & 2 has not entered the economy. This is because banks are holding the new cash in the form of excess reserves, and receiving interest from the Fed. In the past, interest wasn't paid on excess reserves, so this is a completely new tool introduced by Bernanke. Anyway, we'll have to watch whether QE 3 ends up in excess reserves, or makes it out into the economy. The Fed could also lower the interest rate on excess reserves, which would incentivize banks to lend. My take is that at some point all of this money will flood the system and lead to some pretty significant inflation.