This is why QEs did not lead to hyperinflation yet

The economics world has gone gaga for monetary stimulus. Not too long ago, 2006, a good part of the economics profession was saying good bye to the business cycle and was settling in for perpetual growth. They attributed that anomaly to innovation especially in the financial sector. Today another crazy idea gets embraced by economists of all levels, Nobel prize winners to students: long periods of easy money do not lead to (hyper) inflation.

Their basic idea here is that the FED, ECB, BOE  (even our local NBR) should just buy assets from the real economy or keep money at zero real rates for very long periods of time. They have different targets or objectives in mind but in the end all believe that more and more money will not lead to inflation. I am sorry but this is just a myth that in the next few year(s) will be destroyed by the reality, much like the other myths( i.e. ever growing house prices).

In what follows I will show you that QE has lead to dramatic money printing with no real effect on the economy ( no surprise here ). Also, I will show why we are not seeing any hyper inflation YET.

First, here is the measure of money M1 in the US. Low interest rate in 2008 increased the money stock somewhat but QE1 and QE2 have added the exponential dimension to this development.

If  you are not convinced by that graph here is another showing that there are too much money around: velocity of M1. This one shows that money now changes hands at a worrying decreasing rate eroding its purchasing power.

Did the flood of money help the real economy? As expected no. Ironically, the lack of response from the real economy  the reason for why we are not seeing hyperinflation in the US as of yet.  Below is the employment number which is on the right track but still far away from the peak of 2008.

On the other hand the unemployment story looks bleaker as it can be seen from the graph below.

But, to me the graph below says it all. It shows both that the QE and money printing did not help real growth but also why we are not seeing hyperinflation in the US yet. To some this graph shows that the FED has not done enough, but put in the context of the money supply and money velocity I would say that the FED has done too much and it needs to stop the nonsense.

And here is the inflation. Yes it is not at hyperinflation levels but in one year , 2011, it moved from 1% to 4% which is close to the high of 2006 in the middle of strong economic growth. So, US managed the performance to have an inflation  level in a year of low growth – way below potential – with high unemployment and barely no credit at the level from a year when the economy was booming.

What will happen when the economy will be growing close to potential?


11 thoughts on “This is why QEs did not lead to hyperinflation yet

  1. Hi, This time I beg to disagree with you.
    There are two purposes to monetary expansion; the one you mention (sustain aggregate demand), and at least as important, provision of liquidity and SAFE assets to the public.
    In a liquidity trap situation, is not surprising that monetary policy loses traction. Actually, it is the definition of a liquidity trap…
    But, still, there is a need for safe assets by actors (banks, firms, households). Central banks today are fulfilling this role. Not sustaining aggregate demand. That should be left to fiscal policy, if int his world there was some sanity…

    For the moment we see no inflation, because the increase of supply barely matches the increase of demand. There will time for central banks to withdraw liquidity from the market when demand goes back to more normal levels.


    1. @Francesco
      I agree with the provision for liquidity purpose. About the liquidity trap, it will be there as long as we do not allow bad and insolvent institutions to go bankrupt.

      Theoretically you are right, central banks will have to withdraw liquidity and things will be back to normal. But I fear that when the timer will come they will be slow to do it because they do not know if “inflation is due to supply or demand shocks” or “growth is above potential because of a productivity shock” or “it is good to lean against a bubble because it could just be a driven by fundamentals”. I guess I am just a skeptic.

      I would rather see them do something to improve productivity, to lower public debt, to lower the presence of the government in the economy than to keep using fiscal and monetary policy to kick the can further into the future.

      We’ll just have to wait and see.

    1. @ddr
      There are many similarities between US and Japan, as we can see in Koo’s paper. However, there are also many differences and more important, different time periods in which the roughly same measures were accomplished. Here is another study from Nomura:

      Back to differences between the US and Japan. First of all it is about demographics, more favorable in the US. Almost 23% of population in Japan is 65 or older. Also, Japan deficit it is self funded, although this seems to become difficult to do. Furthermore, the US faced a crisis that was a consequence of over consumption, while Japan faced a over production or over investment crisis. In Japan, they entered in crisis with corporations overly indebted, whereas in the US it was consumers. I think that US have more chances to avoid a prolonged economic slowdown, but also there is a major risk of inflation.

      1. The road may be different but it could lead to the same destination. I don’t know what you mean by over consumption, it was a housing bubble, followed by a banking crysis, as in Japan.
        I can’t see how demographics could help the US in the short run in order to avoid Japan style deflation. Once deflation is entranched it will be very hard to use monetary policy to do anything.
        Loose money leads to inflation, but not if there is a huge demand for liquid assets given that AAA rated instruments are no longer seen as safe-heavens.

      2. @ddr
        YOu are right about Japan. But US is a different animal. The US consumer will never match the saving appetite of the Japanese one. US is a country where you have a big and continuous increase inflow of immigrants. These guy will work hard to buy a house, a car, invest in education etc. – i.e. they would not save.
        I think Japan was the perfect example for US to avoid before the crisis. But using the same solution to get out of it, printing money, will lead to a different conclusion in my view. Much the same as central banks use different instruments to implement monetary policy tailored to their own economies even though in theory they all want to keep prices stable.

  2. US companies have huge savings rates compared to any standards. Just look at Apple’s holdings of cash (roughly 100 billion in 2011).
    Savings rate, dispite the economic downturn has gone up, leaving little available income for an expansion of consumption. There are unused resources in the US economy, companies with idle equipment (just like japan’s manufacturing companies had in the 90’s).
    Printing money is not the chosen solution, it was used to bail out banks and taking over troubled assets (TARP). Those amounts did not enter the real economy in order to create inflation…it’s just idle money, used in order to produce better looking accounting reports.

    1. @ddr
      Indeed there are plenty of idle resources in the US economy. Still inflation, as you can see in my graph is at the level from 2006 when the economy was at/above potential. What will happen in a year or two is my question?

  3. I am not trying to say that printing money and giving them as a present in the hands of the people couldn’t crate inflation, or hyper inflation. But the articole has some flows, concerning the economic growth in the us, and not only.

    For instance, how can we say that in 2006 the us had a strong economic growth? First, it wasn’t actually that spectacular. And, then, the entire economy and growth was a bubble, during the last decade, in us. There was nothing sustainable about it, it was mostly artificial. Almost all the productive activities were down, compared to other decades. You just can’t take this period into account when you talk about economic growth and economic policies in that country, and in most of the euro zone country, because it is irrelevant.

    Then, the potential GDP says nothing, it depends on too many stuff, so you can’t actually say much about it. And it also depends on the way you see the problem, the angle. For instance, that “Romania had a 6% gdp potential in 2008, and now it has 3%” is a bullshit, it makes me laugh. Is the same for the US. They are just dreaming. What were the estimates taken into account, and according to what arguments?

    Then, I don’t understand what do you mean by purchasing power, and why do you consider than it is decreasing as the velocity decreases. And eventually it is increasing as velocity is increasing. Because this seam to be the rationing.

    Then, when we talk about the inflation if we don’t take into account the raw materials prices and the market, we are actually in a mistake. 🙂 And the basic materials prices didn’t go up from monetary reasons, as far as I know about the market, both fundamentally and as market risk.

    1. @Lavinia
      I use official data, thus for 2006 you can see that Real GDP is above Real Potential GDP. Of course we can debate about measures and indexes. However, I think is fairly safe to say that 2006 was the last and best year for US before the current crisis.

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