But, but, but…Inflation!

Five years ago the United States economy was mired in the largest recession in 75 years. Domestic economic activity plummeted:

Unemployment skyrocketed:

(Source: BLS Unemployment Data)

As the gears of the financial mechanisms in this country came to a halt, major concerns about deflation were raised.  A potential depression-like scenario was presented as a real possibility.


In response to the significant recession and faced with the terrifying prospect of deflation, the Federal Reserve bank began with a normal Central Bank course of action: reducing the Fed Funds target rate from a previous level of 5.25% to 0.25%:

As the economy lagged throughout the recession despite a significant easing of monetary policy, the Fed began to take the more unprecedented step of Quantitative Easing, expanding the Fed’s balance sheet in open-market bond-buying operations.  These steps led to an explosion of the size of the Fed’s balance sheet:

FRED Monetary Base

This near-vertical growth in the monetary base has led to cries of hyperinflation from pundits and prognosticators.  Printing money has to lead to inflation, right?  So what has happened?  Here’s inflation in the last ten years:

Since oil prices spiked and subsequently fell in late 2008 to early 2009, inflation has been moderate and the last two years have been witness to a decline in the rate of inflation. Oil prices have remained subdued, and remain well below the pre-recession highs as well:

And what about market expectations of future inflation?  We can compare nominal government bonds with TIPS (inflation-adjusted government bonds) to see how much inflation the market expects.  A large spread between the yield on TIPS and nominal bonds would imply expectations of high future inflation:

The current spread shows us that the expectation for ten-year annual inflation is less than 3%, a rate stable for the last few years and in line with long-term normal targets.

So why haven’t we had inflation?  It’s because the Fed “printing money” does not directly increase the supply of dollars in circulation, it is simply a transfer of cash to Federal Reserve member banks.

It is bank lending that creates deposits, increasing the money in circulation. And here’s bank lending:

Commercial Bank Lending
Commercial Bank Lending

You’ll see that during the recession, bank lending dropped dramatically on a year-over-year basis in 2008 and 2009. Lending has normalized around a 1% growth rate, but we have not seen a surge in lending on par with the increase of the Fed’s balance sheet. It’s important to recognize that Quantitative Easing is just an asset swap (cash for bonds) and is simply an aggressively easy monetary policy designed to bring down long-term interest rates.

Note that many of the hyper-inflation hollering, gold-bug pandering prognosticators have a financial or political motivation to predict the apocalypse when it comes to the value of the US Dollar.  Many of them are selling gold products, or trying to get themselves on CNBC, or simply hoping to be (re)elected to public office next fall.  Reasoned investors will find value in understanding our monetary system and looking at actual data rather than creating a frenzy over a make-believe nightmarish world.


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