As I listen to commentary on cable TV about the Fed’s quantitative easing, I find it amazing that people smarter than I, as well as better trained and more knowledgeable about many things, keep making the same mistake they have made for the past three or four years. Their predictions of an inflationary break-out and/or a collapse of the dollar haven’t come true during this time, but instead of going back and reviewing their assumptions, they merely say it is bound to happen even though it hasn’t happened yet.
What they fail to grasp is that their initial assumption that the Fed is printing boatloads of money simply isn’t true. If it were true, I would join them in their dire predictions. But it simply isn’t true and hasn’t been true throughout this period. The latest estimates from the Fed’s H.6 Money Stock Measures show M2 growth actually declining since the Fed resumed significant asset purchases last fall. M2 growth in the three months ending in February was 4.6 percent; it was 6.5 percent in the previous six months and 6.8 percent over the previous 12 months. Even this moderate growth is muted by the average decline in M2 velocity of around 3 ½ percent in recent years, yielding a growth rate of nominal GDP of roughly 4 percent per year.
Asset purchases by the Fed normally lead to a multiple expansion of money since, at the margin, reserve requirements are only about 10 percent of deposits. The roughly $2 trillion of asset growth from before the financial crisis through QE2 was largely offset, however, by an expansion in excess bank reserves of $1.6 trillion. In other words, the banking system has been sterilizing or neutralizing the impact of the asset purchases on the money supply. The good news is this is why we haven’t had an expansion of inflation or a collapse of the dollar. The bad news is that is also why the purchases have not stimulated economic activity more than they have. The effect seems to be limited to the downward pressure placed on interest rates.
The Fed’s asset purchases have been increasing bank reserves. The Fed adds Treasuries and Agency MBS’s to its assets and pays, in effect, by crediting the reserve accounts of the banking system. But that’s where it has been stopping.
It is true that the Monetary Base, which used to be considered high-powered money because it consists of currency outstanding plus the reserves of the banking system, expands with the expansion of bank reserves. But, with banks hoarding excess reserves as they have been, the Monetary Base has not had its historical impact on the public’s money supply. If one insists on calling the Monetary Base ‘money,’ then it is money that has gone only to the Treasury and the sellers of MBS’s. This has made the financing of our outsized deficit easier and cheaper. That will come to an end some time and financing the deficit will become more expensive; then holders of fixed-income securities will experience market losses if they sell them before maturity. But there are no inflationary pressures building.