Why inflation isn’t higher even though money is flooding the economy
The belief that increasing money supply leads to inflation does have a distinguished theoretical foundation
I rely heavily on a recent research report by two members of the Asset Allocation team at Boston-based GMO (James Montier and Philip Pilkington).
https://www.gmo.com/europe/research-library/part-1-inflation--tall-tales-and-true-causes/
As Montier and Pilkington point out, this equation in itself is largely unobjectionable, since it simply holds that “expenditure equals income, which is nothing more than an identity.”
Yet to translate the formula into a forecast about inflation, they note, “one has to make some rather unrealistic assumptions, such as velocity being fixed and output being fixed.
There is no agreement on what even counts as money in the first place.
Take what happens when the Federal Reserve purchases bonds as part of its Quantitative Easing program. As Montier and Pilkington explain: “Essentially, the Fed buys fixed income assets (like government bonds) from the private sector and issues cash/reserves in their place. The former aren’t defined as part of the money supply, whereas the latter are. Hence QE leads to increases in the money supply.”
Does QE therefore really represent an increase in the money supply? It could also be viewed as a “maturity transformation,” in which longer-term debt is swapped for shorter-term debt.
Mark Hulbert MarketWatch1 Aug. 28, 2021
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