We keep reading newsletter commentary warning “the end is nigh” because the Fed is “printing money”. The good news is that is wrong. The bad news is that we still have not figured out how to get the banks to begin converting the US$ trillion in reserves into loans (the beginning of private money creation that leads to inflation). Jim Hamilton wrote a nice short essay last month on this:
(…) But conditions at the moment are far from normal. In particular, something quite remarkable has happened to the demand for the monetary base. In the current environment, banks have shown themselves to be indifferent between holding reserves (a risk-free way to earn a modest interest rate from the Fed) and making other uses of overnight funds. For this reason, the demand for reserves, and with it the demand for the monetary base, has ballooned without any corresponding changes in output or inflation.
Some people felt I was making a sophistic distinction in emphasizing that the Fed is creating reserves as opposed to printing money (, ). But I maintain this is a critical distinction. The demand for reserves has increased by a trillion dollars since 2008. The demand for currency held by the public has not. The supply of reserves could therefore increase a trillion dollars without causing inflation. The quantity of currency held by the public could not.
Now, the time will come when banks do see something better to do with these reserves, at which point the Fed will need to take appropriate measures in response, namely a combination of raising the interest rate paid on reserves and selling off some of the assets the Fed has been accumulating. This is of course a key long-term story that we will all be following with interest.
But someone who insists that inflation (P) must go up just because the monetary base (M) has risen may have lost their marbles.
As I write, US commercial banks still have not restarted lending: