A subscriber asks; How can price inflation remain low with an expanding monetary base?

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There is a sincere debate… regarding how there could be a 5x expansion of monetary base in 2008 (and a subsequent spike in M1 currency) and yet the real world price levels (CPI inflation) have not noticeably risen. It is my belief that this has been made possible by:

(1) interest on excess reserves (IOER) that essentially bribes/incentivizes banks not to lend, IOER caused no/low/contained consumer credit expansion means no price inflation (M1/physical currency increase is probably irrelevant) because prices generally correlate with credit; and

(2) something in Dodd Frank/Fed policy (I don’t know what) since 2008 that has allowed the Fed to directly monetize assets, specifically USTs—I believe you have correctly said that Fed has complete control over the yield curve, I’m not sure I’ve heard specifically how it has done this.

If you can explain number 2 specifically and how Fed can directly control/prevent a drop in asset prices, I think you will help more people and your correct message will get further amplified.


M2 as a % of GDP has been climbing for decades. Since the Fed is making sure all the debt outstanding is serviced, the deflationary forces persist and magnify, even as currency measures rise
As nominal GDP rises over time, M2 as a percent of GDP has been climbing faster. Hence, the drop in velocity. The velocity of money is the frequency at which one unit of currency is used to purchase domestically-produced goods and services within a given time period. In other words, it is the number of times one dollar is spent to buy goods and services per unit of time. If the velocity of money is decreasing, then less transactions are occurring between individuals in an economy.

-The higher the levels of in-service sovereign debt outstanding (e.g. US Treasuries), the higher asset prices will be, ceteris paribus. My observation has been that monetary growth is a much less precise indicator.
-Prior to 2008, monetary growth strongly correlated to higher general price inflation as a very low percentage of Mb and M1 was sterilized.

The United States has a more developed monetary system, it’s M2 as a % of GDP is less than most  other nations. Japan’s economy has a higher level, because of its decades-long debt and asset monetization programs. Will the U.S. trend higher like Japan?

-In 2008, for the first time the global investors questioned how the nation-states would be able to stay in business. The successful implementation of the QE and asset purchase programs solved that dilemma.
-The Fed and other central banks could have chosen a number of routes in the wake of the 2008 crisis. They chose the current path of debt monetization and balance sheet additions. I am not here to say if this was wise; I only observe. This provides the nation-state governments with the money to operate.
-Prior to 2008, the world’s net savings rate and its balance sheet supported sovereign nation-state spending. Subsequent to 2008, QE was needed to keep nation-states borrowing and their spending needs growing.
-Since 2008, the global economy is no longer large enough to service the growing levels of outstanding debts, under normal circumstances (economic laws prior to 2008). Thus, the QE programs effectively act as a huge deflationary force. So, money velocity slows and the amount of money supply needed to operate the economy increases over time.

The Fed admits that it needs to maintain its IOER program and uses it as a vital monetary tool. Without it, there is a hyperinflationary risk to the system.
If the banks can borrow from customers at near 0% in checking and savings, why bother lending?They can deposit all that money at the Fed risk free. They can shut their branches and layoff their workers, and this money becomes effectively sterilized.

-Since the promulgation of QE and the IOER program, large portions of the money supply have been effectively sterilized.
The Fed admits that the IOER program is vital to keeping inflation lower. I agree. Keep in mind that as debt levels rise and money velocities slow, M2 must rise to keep the nominal GDP growing.
-If the Fed really wanted to increase consumer price levels, it should lower the rate of interest on excess reserves. But it won’t, because the lower the level of consumer prices, the more viable their QE programs.

As serviceable debt levels rise, the amount of money required increases over time when compared to GDP growth. Velocity drops and debt burdens to the economy climb.

-With the amount of US Treasuries rising and the dollar firm, USD-denominated securities should continue to be better supported than elsewhere. This paradigm should continue as long as the dollar is the reserve currency.
-My primary immediate concern on this current course of action is this; The Fed and Treasury seem to becoming less concerned over the repercussions of their actions. This means asset prices may move much higher than anticipated. In essence, as they grow more desperate, they may stop pretending to care.
-The Fed does effectively control the entire yield curve. As long as all the Treasuries are being serviced, yields will fall over time as an ever greater portion of GDP is committed to prior debt service.
-The Fed isn’t actively managing the yield curve, per se. Rather, QE by function will force rates lower over time as the world struggles to service debts and sinks further in a sea of deflationary red ink in which debt is never repudiated. This was easily apparent in the wake of the Fed’s about face in late 2018. Yields across the board fell and the yield curve flattened.
-Fed jawboning can play a part in managing yields, especially on the longer end. Longer-dated QE would also do the trick.
-With respect to William’s second question, The Fed is prohibited from buying stocks. It can only purchase Federal securities, such as Treasuries and Mortgage-backed securities. Please refer to this section of the Federal Reserve Act for more information.

Links for more information:
Federal Reserve Act – Section 14. Open-Market Operation
Money supply
Should We Worry About Excess Reserves?
Interest on Excess Reserves and U.S. Commercial Bank Lending

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