Purchasing Treasuries, Printing Money, And Runaway Inflation

I’ve tried to straighten this out before, but it obviously didn’t take; so I’ll try again.

Over and over on financial TV, I hear commentators and guests alike talk about how the Fed is printing money when it buys Treasuries (meaning long-term) and how runaway inflation is the inevitable result.

*The Fed doesn’t literally print money. Most people who use that expression probably know that, but some obviously don’t.

*The Fed does “create” money when it purchases an asset, but that is just as true whether the asset purchased is a 10-year treasury bond, a 3-month treasury bill, or a sack of potatoes for the cafeteria.

*I can’t understand why people treat the purchase of longer term treasuries as something qualitatively different from purchasing shorter term treasuries. Money is created in both cases, and the inflationary potential of the money creation is the same.

*What that inflationary potential is depends not on what was purchased, but on how much money was created by the purchases. It will tend to be inflationary if, on a sustained basis, money creation is substantially larger percentagewise than the capacity of the economy to grow in real terms. That real growth capacity is larger in a deep recession than if we are already fully employing our resources.

*To be redundant, if the Fed buys $20 billion of 10-year notes and simultaneously sells $20 billion of 90-day bills there is no net increase in the danger of inflation.

*I hear some say the danger of inflation will be realized when all those excess bank reserves sitting on the balance sheet of the Fed are utilized. Maybe so, but remember the lesson of the 1930s when excess reserves turned out to be excess only in a regulatory sense. They weren’t excess to the banks which held them as precautionary balances in troubled and uncertain times.

*Today’s excess reserves may not be so excessive either. Premature attempts to “mop them up” to avoid future inflation could well send the economy down again.

*Another important question has to do with the expansion of the Fed’s balance sheet and the resulting impact on various measures of money.

Yes, the balance sheet rose rapidly, and by a lot. But that increase took place almost entirely between September and December 2008. There has been no additional net increase in the balance sheet since December. We are going on six months of no expansion. So while year to date numbers still look large, they haven’t grown in five months.

*I’m not sure what that pattern of start and stop means for inflation, but I’m pretty sure it means less than start and keep going would have meant.

*The excess bank reserves on the Fed’s balance sheet contributed to a humongous spike in the monetary base. However, M1 and M2 went up fast and then back down fast. Both are essentially flat year to date-not what you would expect to lead to hyperinflation. The behavior of the price indexes of the past few months support that conclusion.