Quantitative Easing and Inflation
Quantitative Easing
In 2008, with the United States in economic free-fall, loosing upwards of hundreds of thousands
of jobs a month, the Federal Reserve, the monetary policy maker of the United States economy, decided
to take unprecedented actions to stimulate positive market responses and to halt the steep losses in jobs.
Starting November 2008, the Federal Reserve engaged in a new transaction coined “quantitative easing:”
the buying of financial assets from banks through open market operations, hoping to saturate banks with
excess cash reserves. The hope would then be that the banks would lend out all this new money to restart
a cycle of investment and consumption, stimulating the economy.1
Three different rounds of quantitative easing have taken place since 2008. As a result, the
monetary base, the sum of currency in circulation and reserve balances, has drastically increased in the
United States economy; for
example, by itself, QE1
totaled approximately $1.25
Trillion dollars.23 That is, at
least, $1.25 trillion new
dollars that were artificially
introduced
into
the
economy that would have
otherwise not taken place
with a historically normal
Graph 1- Monetary base expansion, in billions of dollars, 1980-2013
market. Thus, what are the
results of such actions by the Federal Reserve? What have the short run implications been and what does
1
"What Is Quantitative Easing?" BBC News. BBC, 03 July 2013. Web. 15 Sept. 2013.
"Current FAQsInforming the Public about the Federal Reserve." FRB: What Is the Money Supply? Is It
Important? Federal Reserve, n.d. Web. 15 Sept. 2013
3
De Costa, Polyana. "QE1: Financial Crisis Timeline." QE1: Financial Crisis Timeline. N.p., n.d. Web. 15 Sept. 2013
2
the quantity theory of money tell us about possible long run implications? The quantity theory of money
states that increases in the money supply of an economy will lead to a proportional unit increase in the
price level; that is, money supply and inflation increase by proportional amounts.4 Because the monetary
base has reached uncharted waters—it has more than doubled in less than 3 years—we should be
experiencing equally uncharted levels of inflation.
The Short run
Nevertheless, three years
after the first round of quantitative
easing
has
been
completed,
increases in the price level have not
been identical to the amount of
money infused in the economy. In
Graph 2- Quantity Theory of Money
Theoretically, the Federal Reserve has helped shift the blue line to
the right, decreasing the value of money, thus increasing the price
level, or inflation.
fact, the last 15 consecutive months
have all seen core inflation at a
level below two percent, a number
relatively lower than the United
Graph Source: Sparknotes
States’
historical
monthly
average.5 In fact, 2009 saw deflation, or net decreases in the price level, despite the $1.25 trillion dollar
QE that took place over that year.6 Thus, in the current short run, the quantity theory of money has not yet
predicted out current economic situation.
4
See graph 2- quantity theory of money
"USA Inflation Rate." USA Inflation Rate. Rate Inflation, n.d. Web. 15 Sept. 2013.
6
De Costa, Polyana. "QE1: Financial Crisis Timeline." QE1: Financial Crisis Timeline. N.p., n.d. Web. 15 Sept. 2013
5
Inflation
Graph 3- Consumer Price Index: Core and Volatile
Nevertheless, inflation, as measured by the
Federal Reserve, reflects “core” price levels;
namely, the market prices of items that are not
volatile and subject to exogenous events. This
is why items that have unstable prices, such as
food and energy, are not included in the
official calculus of the Federal Reserves’
definition of inflation. Thus, price levels are
always more stable than they otherwise would
be if all items were included in the calculation of inflation. Some economists believe that, while QE has
not yet caused core inflation to take place, it is influencing overall inflation in the areas of food and
energy.
However, even with the volatile areas of food and energy included, overall inflation is currently
not spiking, indicating that QE has not caused overall inflation.7 If QE had caused overall inflation, it
would be rising at an exceptional rate.
The long run
However, the quantitative theory of money applies to the economic long run, a unit of time not
bound by typical intervals. Instead, the economic long run applies to a point in the future where all inputs
are not fixed and can be varied. It may so happen that we have currently not yet reached the economic
long run. If the quantity theory of money proves to be correct we will not want the future to arrive either
because unprecedented, run-away hyperinflation will wretch havoc on the United Sates economy.
7
See Graph 3- Consumer Price Index: Core and Volatile
Conclusion
Given the amount of new money helped created by the Federal Reserve and QE1, QE2, and QE3,
it certainly is curious as to why we have not seen even a slight abnormal growth in inflation. Graph 1
truly shows that the United States economy has entered uncharted waters in respects to the monetary base.
Perhaps banks unwillingness to lend all the new money safely stored in their excess reserves plays a part.
Money cannot truly enter the money supply from banks unless it is loaned out. Or perhaps, the quantity
theory of money is flawed in our current economic snapshot because of intricacies and complexities in the
21st century economy; it is unlikely but only time will tell.