QE and Inflation

Hopefully one of my more learned pinster colleagues can explain this but how come with the amount of global QE (US, Britain, Euro version) do we not see a spike in inflation worldwide. It seems to be creating asset bubbles in property, bonds and some equity markets but no huge jumps in inflation. Can anyone explain why without getting overly technical?

My entirely speculative and uneducated thoughts are that QE is not reaching consumers, so no significant inflation in consumer prices.

The printed money being pushed through financial institutions with broken balance sheets, making them very risk averse. The financial institutions are leveraging up and providing the credit to the least risky borrowers, people who don’t need the money.

Since consumers are still hurting, there’s no point in the people who have the capacity to borrow to invest in the production of goods or the delivery or services, who’s going to buy them? That pushes the free money into speculative asset classes in the hope of a return.

I’m not an economist, but I can see the futility of this strategy.

That would make some sort of sense i.e. why buy a factory making something when you can just buy the building and rent it out. Surely though endlessly printing money (for all intents and purposes) will lead to inflation or am I missing something obvious.

There are several alternative answers.

  1. QE isn’t money-printing, it’s an asset swap. In theory the swap will be reversed in future. Since inflation is largely driven by expectations, expectations take into account the future unwinding (reversing) of the swap and so people don’t believe the inflation will stick. So it doesn’t happen.

  2. QE was designed to be inflationary but the baseline is not prices as they were, but prices as they would be if QE hadn’t been applied. QE was introduced to combat the threat of a deflationary spiral, and flat prices is higher than falling prices.

  3. QE is a plot to enrich bankers and the 1%.

  4. Nobody has a clue; economics is a makey-upped pseudo science.

…and so on.

Krugman has a piece on Japan which is relevant.

krugman.blogs.nytimes.com/2015/1 … ing-japan/

This is, eh, brave.

As I see it the entire purpose of small positive inflation as a policy target is to steadily erode accumulated wealth that’s sitting around doing nothing and thus force higher utilisation of capital (people, stuff) with the objective of reducing unemployment and furthering civilisational development. If this is true it would make life a lot easier if policymakers and economics would admit it rather than bollocking on about the "Wicksellian natural rate of interest " or whatever and we could all just get on with the raining of the cash from helicopters, almost literally.

But what would I know.

  1. QE is “asset backed” printing. It is not the same as FED printing $ and handing them out (famous “helicopter” image).

  2. In theory, the FED could repay the QE printing with the assets it bought and the trade is effectively cancelled.

  3. QE is therefore like an “asset swap”, where the FED take bonds out of the system and replaces with printed cash.

  4. The market of assets is like a “bathtub” and will find its own level. Therefore, with bonds gone, IN THE ABSENCE of investors wanting to hold cash, the price of other assets must rise.

  5. I emphasis “THE ABSENCE” because a critical part of QE is making people fearful of holding cash. Cash holdings by managers during QE typically go to very low levels. The fear is that QE does produce a “Wiemar Republic” moment.

  6. There is nothing in 1-5. that would drive ordinary price inflation directly (unlike “helicopter” printing), however by ramping asset price inflation, the FED is hoping that the wealth effect leaks into ordinary price inflation.

  7. The reason why is doesn’t was explained in detail by Richard Koo, the famous Japanese economist. Every time a QE program ends, managers seem to be less fearful of holding cash. There is a sell-off in risk assets, which creates a fall, and breeds an even bigger sell-off (“crowded theater vs. small exit” issue). You then have more cash, chasing fewer bonds, then were there pre QE.

  8. The result of 7. is that the yield curve hits a new low. Every time BOJ or FED finished QE, the long-end of the yield curve hit a new low and the yield curve flattened more (deadly for financials - and why the usually collapse post QEs).

  9. The result of 8. is that when the vast bulk of a country’s capital base, which is in bonds, is rolling over at almost 0% (vs. 4%), that is highly deflationary. Imagine an country where everybody is getting 4% on their risk free money. That is automatic inflation every year. Contrast with a country that is getting 0% on their risk free money. That is very different.

  10. Koo also showed that not only does the flattening yield curve literally take money out of the private sector’s hands (and drops it into the BOJ’s hands who pocket the carry), but a 0% return, makes people fundamentally change habits and become even more austere. Which in itself is very deflationary.

The irony is that the BOJ which still holds the world record for QE (in almost every dimension), gave it up after 10 attempts, as it created a very deflationary environment in Japan (ironic, that inside QE, is it’s own antidote). It was only Krugman (and this has been documented), who convinced Abe to try harder. Track the Nikkei ETF in USD, which is EWJ. Over two years years of $1.5trn by the BOJ, and EWJ at close to $11.50 is almost exactly back to where it was when BOJ’s QE11 was passed.

What ultimately will happen, is that the FED (and others) will start to regulate wages. Now that private sector unions are all but dead, the only way to really get ordinary price inflation back into the system is either to (1) dramatically increase min wage and/or (2) dramitically increase interest rates. They have lost control of (2) from excessive QE, and I believe we are seeing the “green-shoots” of (1) all over the place with min wage increases (and even firms like WMT, to their own cost, rising wages). This will of course be bad for assets in the near-term but it is hard for the world to escape some form of 1970’s environment, if it wants out of Japan’s / Richard Koo’s famous liquidity trap. HOWEVER, Japan has itself shown - despite words - no real stomach to do this.

Hope that makes sense.

Cheers, kind of. will need to re-read a few times to get a full understanding

In October 2008 the FED introduced paying interest on exccess reserves (IOER). Excess reserves at the FED went from $10bn in August 2008 to $880bn by January 2009 and were at $2.3th by Q3 2013 so a relatively good portion of the QE money was effectively “sterilized” in the US.

Agree with almost all of Observer’s post above.

Would also add that it is key to understand, because the media and even market participants (who should know better) continue to pump the line “Banks will lend out their reserves” (thus creating demand led inflation) that banks do not lend reserves.

As confirmed by:
The Bank of England here
S&P here

Even Bernanke and Krugman get this wrong:
Bernanke 2009: “But as the economy recovers, banks should find more opportunities to lend out their reserves.” :frowning:
Krugman 2012: "“First of all, any individual bank does, in fact, have to lend out the money it receives in deposits. Bank loan officers can’t just issue checks out of thin air” :confused: :laughing:

Thanks Daniel

Would also agree fully with your point above re banks not lending excess reserves - this was another of the great mis-conceptions of Q.E. (along with the notion that it was “inflationary” vs. actual experience is “deflationary”).

There is probably a small caveat which is that banks have probably been more aggressively fueling margin trading with excess reserves (i.e. they can’t create “true” loan demand, but they can get more involved in trading).

I believe that this could be the driver for the greatest expansion in margin debt we have seen in modern times:


Because trickle-down isn’t working.

Dont know about your neck of the woods but the reason the official inflation rate in the US is so low is because it no longer tracks real world price rises. Its called the COLA effect. Real world prices for everything I buy, except petrol, has gone up at least 30% to 50% in the last 5 years. Some, utilities, have almost doubled. But the official inflation rate in the period was around 10%.

We have gone way beyond the hedonistic multiplier scam by this stage. The official numbers are meaningless. I dont remember such a sustained period of noticeable real world consumer price inflation since the early 1980’s. The difference was, back then, what one saw in product prices rises in the shops was accurately reflected in the official numbers.

QE is deflationary because it suppresses inflation expectations by raising demand for long term assets. It diverts money from riskier investments, because there’s money to be made doing something with zero risk. As it suppresses inflation, the zero risk becomes more attractive, feeding itself down to zero inflation, zero interest rates.

As investment is suppressed, demand for labour goes down, so wages stagnate or fall relative to the cost of inflation-excluded assets - eg houses and financial assets. Laboursvshare of wealth is reduced and this in turn dampens the other engine of the capitalist economy, consumption. That too feeds into deflation.

With wages stagnant, you’d expect unrest, but global labour competition means gheraos have no traction.

It’s all bad news, really.

Of course it doesn’t because no one ever suggested trickle down as an economic theory.

WMT upped min wages, then cut staff. How do you think the Fed can regulate wages?

Good post BTW.

The FED tells the U.S. government to announce that on Monday morning, everybody in employment is getting a 10% pay rise. And that this will happen ever year for 5 years. That would cause havoc with assets, but would create immediate inflation (the kind the FED wants that eats into indebtedness). There are other more subtle ways of this with other issues - i.e. generous public servant pay rises, generous public works employment schemes etc.

It seems mad that Japan have been inspired to flog the donkey again (despite the fact that it is now more of a carcass), but that is what has happened. However, over 2 years and $1.5trn of BOJ QE and things have not really changed.

However along with deflation, there are more serious social issues from QE due to (1) high prices, from QE pumping assets, and (2) low growth prospects, from the deflation of QE. These issues are mainly around falling birth rates (too expensive to fund children + youth loosing belief in economy designed to fund the payments of over-inflated assets owned by older generation.), and falling labour participation rates. There was a great piece done showing correlation of low birth rates in highly leveraged economies (Ireland being a perverse exception !) including Japan, Holland, Nordics etc.

I believe a time will come when these social issues will come to the fore. Younger generations will demand to break-free from a society where they have to maintain the ponzi of crazy high asset prices to fund out the older generations etc. They will demand higher wages and better standards of living. They will, in essence, re-create private sector unions.

What, having more children is perverse?

So you’ll think we’'ll see an end to our social welfare system and fractional reserved banking?

Spot on.
And about time too.


No. Normal, working people will just demand their fair share.

Mmmm… in case you haven’t noticed, the whiney cry baby occupy movement has failed.

Great post. Insightful.