In the previous post I have tried to explain that the amount of central bank money (reserves) available in the banking system do not influence the lending decision of financial institutions as they come into existence after loans have been issued. Another discussion on alphaville, initiated by conversations about the lasting effects of QE on the money supply and inflation has motivated me to write this quick post.
Yes, QE is an asset swap, essentially swapping government and mortgage-backed securities for base money (central bank reserves), and yes, it also is an expansion of the FED balance sheet and Ben Bernanke does refer to this process as turning on the printing press. However central bank reserves are not the only form of “money”. The private sector can also create money.
Furthermore the weekly/monthly publications in official statistics do make it easier to measure base money than credit/debt in the shadow banking system and specific collateral requirements. However this seems to be a classic “framing” behavioural finance trap that an excess amount of reserves will lead to an increase in commercial bank money through the money multiplier process.
Also inflation has not been absent in the last decade. Admittedly, looking at the CPI data, price levels have been very stable but by taking house prices (Case-Shiller Index) and total credit market debt (FOF Total Credit Market Debt) into the equation the chart below shows that up until 2008 the latter two series have increased far beyond what the aggregate CPI level would suggest. Also reserves only accounted for 20bn compared to 50trn in overall debt. Inflation and Home prices are rebased to 100% (shown on LHS) in 2000 and credit market debt and reserves (RHS) are measured in USD bn.
The 2nd chart rebases all 4 series to 100 and only the reserves are shown on the RHS this time. While inflation measured using CPI has been very constant, house prices and credit market debt have risen in excess of what would have been suggested by CPI levels. Also and more important for the point being made here, is that the reserve levels bear no resemblance to the overall amount of debt and inflation. I am not suggesting that with 100% certainty, these new policy tools will prevent/avoid inflation but the facts would not suggest an immediate outbreak of inflation. The massive dent (deleveraging) in private sector money creation after a 100% increase in 8 years can serve as a plausible explanation.
To sum up, just because it is easier to measure excess reserves and inflated central bank balance sheets than the complexities of private sector money creation it should not be blindly inferred that an increase of the former two factors will necessary lead to an inflationary scenario. Perhaps an increase in reserves could also be seen as a contrarian anti-inflation indicator?