To Paul’s second point, I think the increase in banks’ holdings of cash in their accounts at the Fed is a reflection of a combination of their reluctance to lend (either directly or via the purchase of debt securities) and weak demand for credit from the private sector. As yet I don’t think there is any evidence of ‘crowding out’ by the Fed’s purchases of mortgage-backed securities. Indeed, if and when private investor demand for those securities begins rising, that will itself serve as a market signal for the Fed to start offloading its holdings of them.

By my calculation, M2 has risen by 7.9% between September 2008 and February 2010 which as Paul says is considerably faster than nominal GDP (less than 1%) so velocity of money has indeed declined – as one would expect in a recession, particularly one in which financial dislocation has played such an important role. Again, the Fed needs to be alert to the timing and magnitude of the eventual recovery in velocity when calibrating its ‘exit strategy’.

Among those who have compared the Fed’s ‘quantitative easing’ strategies with those of Weimar Germany or Mugabe’s Zimbabwe are Marc Faber (‘US Inflation to Approach Zimbabwe Level, Faber Says’, Forbes, 2 June 2009) and Bill Gross (‘Gross Says Diversify from Dollar as Deficits Surge’, Bloomberg, 3 June 2009), as well as any number of gold-bugs, self-proclaimed ‘Austrians’ and others on the internet and among investment newsletter writers.

These references may also be of interest to ‘Tel’ who berates me for not providing any; I can only say that this was originally an article for a newspaper, and it’s not usual to provide footnotes in newspaper op-ed pages (especially those subject to word limits). Whatever gold is in Fort Knox will stay there; the US dollar hasn’t been convertible into gold since 1971.

I think it’s a long bow to draw between the Fed’s ‘quantitative easing’ and the large rise in the PPI in March, reported on Friday night our time. As ‘Tel’ notes, this was largely driven by a sharp rise in the (highly volatile) food component. The overall PPI rose 6.1% over the year to March, but its absolute level is still below where it was in September 2008. Meanwhile the ‘core’ PPI (excluding food and energy) rose by just 0.1% in March to be only 0.8% higher than a year earlier. More generally, much of the movement in producer prices reflective changes in relative prices – in particular, increases in commodity prices driven in large part by demand from emerging markets – rather than in the overall price level (including services). Consumer prices excluding food and energy rose by only 1.2% over the year to March. Not much sign of inflation there.

http://www.businessinsider.com/hidden-in-the-ppi-data-was-the-largest-food-price-spike-in-26-years-2010-4

The big story in the March PPI was wholesale food prices, which rose 2.4%, matching the biggest gain in 26 years. Prices of fresh and dried vegetables soared 49.3%, the most in 16 years.

Inflation would only become a risk if the Fed failed to unwind the expansion in its balance sheet once the banks start to lend out the funds which they are currently holding as reserve balances with the Fed.

Unwinding would require selling off the same mortgage backed securities for something close to what was paid. Given the 30% fall in value of the houses sitting underneath these securities (and the continuation of mortgage defaults to the point where the banks don’t even talk about it anymore) you must be expecting a buyer to fly in from the North Pole with a big white beard and a red hat.

But the Fed has made it very clear that they are aware of this risk, and have both the inclination and the means to deal with it when it arises.

Thank you for being so reassuring. I notice that you hesitate to elaborate on any details nor do you provide references, but on a hand waving guess I presume we are talking about those submarines full of gold bars on their way into China. :-) Sure, this deals with the inflation problem… temporarily… until neither Fort Knox nor the Comex have any metal left in them.

Interesting piece. Acouple of small points. You make a sharp distinction between the actual current decisions of the Fed Reserve and the actions of the Federal government, making it possible to say that the increase in debt of the Federal Government via foreign holders is not an inflationary pressure that can be blamed on the Federal Reserve. It does in principle add inflationary pressure, but simply not due to the Reserve. Many commentators wouldn’t make such sharp distinctions partially because they would, either implicitly or explicitly, think that when push comes to shove the Federal Reserve would roll over Government bonds if no-one else did, and hence partially blame the Reserve for allowing the money supply to be increased via borrowing of the Government.

Second, if you want to argue about the effect of the loans to banks on inflation, its no good just talking about the amount of money banks hold at the Reserve without looking at whether this has crowded out other securities banks could have held and hence whether it hasn’t indirectly increased their lending activities (these loans were certainly meant to get banks lending again!). I am not going to put in the effort to see if this has happened, but will note the possibility.

Thirdly, since the Fed is ultimately in the position to get the money supply to whatever level it wants, you can in principle blame it for the level of money supply out there and hence look at the levels to see whether it has ‘allowed’ monetary expansion. If you look at M2 for the US (http://www.federalreserve.gov/releases/h6/hist/h6hist1.txt), you see it has increased by about 700 billion since October 2008, which is close to 10%. That’s quite an increase for a country in recession, but since the velocity of M2 also seems to have gone down, this monetary expansion hasn’t yet lead to the inflationary pressures envisaged.

Of course you are right that the analogy with classic money printing is imperfect, but on the other hand there are now ways of increasing the money supply without direct printing that were not available to the Weimar republic. I guess it would be handy to know which statements by which commentators you directly want to take a shot at.