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So many conservative politicians, I won’t name names, have been on the Feds’ case (Federal Reserve Bank), accusing it of a libertine attitude and a penchant for accommodative monetary policies which will lead, they claim, to the mother of all inflations. They are fundamentally wrong in their economic wager! So far, inflation has not materialized and the sky is not falling. After six long years of easy money policy by the Feds, US Core Inflation rate as of the June report is just 1.9% year over year, and has averaged 1.72% over the first 5 months of the year. The risk of disinflation is not yet off the table. Further evidence of disinflation risk is coming from our major trading partners: UK, the Eurozone, and China, where Core Inflation rates are 1.6% and 0.8%, and 1.7% respectively. So concerned about disinflation is the European Central Bank (ECB), that its President Mario Draghi initiated a negative interest rate policy in June, where banks must pay for leaving money on deposit with the Central Bank – it usually works the other way around! Still not satisfied, Draghi announced last week that the ECB will give banks as much as $1 Trillion in cheap money, if the banks commit to aggressively lending the money.
Back home, the US Feds has the same problem. Despite its asset purchases and long term easy money policy, loan growth at commercial banks remains weak, except for auto loans. This is not only due to tougher credit underwriting standards by commercial banks, but more so because companies are unwilling to commit investments unless they are convinced the economy is growing. This is precisely why predictions of hyperinflation, as some conservatives have gone apoplectic proclaiming, have not materialized and are unlikely to materialize. The process of money creation goes like this. First, the Central Bank (the Federal Reserve in the US) creates money through easing of reserve requirements, or by purchasing financial assets from commercial banks (as the Feds has done through its QE programs). These actions by the Feds create additional capacity to lend at the commercial banks. The commercial banks, in turn, use the additional capacity to make loans to companies and individuals in expectation of profits. This last step is necessary to increase a country’s money supply, and for any corelated inflation to happen. And, it is this last step in the process which is not taking place here or in our trading partners’ economies. So, while economic policy hawks are correct that the Federal Reserve’s easy monetary policy has gone on for a long time, they are not looking at the full picture. Indeed, we need to welcome some additional inflation to ensure the safety of our recovery.
You may reach the author directy through email: mg@goglobal-one.us