The Wall Street Journal recently ran a front-page article reporting that the monetary-policy “doves,” who had forecast low inflation in the United States, have gotten the better of the “hawks,” who argued that the Fed’s monthly purchases of long-term securities, or so-called quantitative easing (QE), would unleash faster price growth
The report was correct but misleading, for it failed to mention why there is so little inflation in the US today. Were the doves right, or just lucky?
The US Federal Reserve Board has pumped out trillions of dollars of reserves, but never have so many reserves produced so little monetary growth. Neither the hawks nor the doves (nor anyone else) expected that.
Monetarists insist that economies experience inflation when money-supply growth persistently exceeds output growth. That has not happened yet, so inflation has been postponed.
Instead of rejecting monetary theory and history, the army of Wall Street soothsayers should look beyond the Fed’s press releases and ask themselves: Does it make sense to throw out centuries of experience? Are we really so confident that the Fed has found a new way?
The Fed has printed new bank reserves with reckless abandon. But almost all of the reserves sit idle on commercial banks’ balance sheets. For the 12 months ending in July, the St. Louis Fed reports that bank reserves rose 31 per cent. During the same period, a commonly used measure of monetary growth, M2, increased by only 6.8 per cent. No sound monetarist thinks those numbers predict current inflation.
Indeed, almost all the reserves added in the second and third rounds of QE, more than 95 per cent, are sitting in excess reserves, neither lent nor borrowed and never used to increase money in circulation. The Fed pays the banks 0.25 per cent to keep them idle.
With $2trn in excess reserves, and the prospect of as much as $85bn added each month, banks receive $5bn a year, and rising, without taking any risk. For the bankers, that’s a bonanza, paid from monies that the Fed would normally pay to the US Treasury. And, adding insult to injury, about half the payment goes to branches of foreign banks.
In normal times, there are valid reasons for paying interest on excess reserves. Currently, however, it is downright counter-productive. Bank loans have started to increase, but small borrowers, new borrowers, and start-up companies are regularly refused.
The rest of this piece can be read at: http://economia.icaew.com/opinion/august-2013/when-inflation-doves-cry#s…
Allan H. Meltzer, University Professor of Public Policy at Carnegie Mellon University and Distinguished Visiting Fellow at the Hoover Institution, is the author of A History of the Federal Reserve. – See more at: http://economia.icaew.com/opinion/august-2013/when-inflation-doves-cry#s…