Inflation is Everywhere and Always a Monetary Phenomena

|Peter Boettke|

Bob Higgs offers an explanation to the puzzle as to why we haven't experienced the hyperinflation that one might expect from the monetary policy the Federal Reserve Bank has followed since 2008.

What do you think?

Comments

[Roger Koppl]

You're not likely to go wrong by following Bob Higgs. It seems clear that paying interest on reserves plus regime uncertainty add up to the impossibility of saying what is a large or small monetary base. They also add up to the risk of sudden swings in the money multiplier as Higgs seems to suggest. The rate of return on reserves is a political variable that will be manipulated at some point. In theory the Fed will adjust the rate to prevent hyperinflation. What could possibly go wrong?

[Mike Sproul]

If a bank doubles the money supply at the same time that it doubles its assets, then it is just like a firm that doubles its issuance of stock while also doubling its assets: Nothing happens to the value of the money or the stock, since the ratio of assets to money, and assets to stock, is unchanged. Furthermore, if inflation threatened such a bank, it has enough assets to buy back the money it has issued at par. This would not be the case if the bank had not gotten equal-valued assets in exchange for the money it issued.

[Silvano]

Banks have to receover their balance sheet. QE I & II prevented a massive liquidation. But anyhow, they know they still have bad loans in their books and many credits aren't so good as it was reported before 2008, now they absorb much more capital. To improve the internal rating and / or the recovery ratio of a bad loan is much more profiting and perhaps less risky than expanding credit. At the same time banks need to be liquid enought to face unexpected losses.
Despite the efforts of the Fed, banks may be "restrictive" simply requiring higher credit scores and tightening up credit standards. They can reduce supply in a "qualitative" way.

[Pietro M.]

What Koppl and Silvano said.

Inflation depends on the flow of monetary services, which is a multiple of the monetary base. This multiplier is not constant, so that there won't be higher inflation if the monetary base skyrockets and banks' willingness to create credit plunges at the same time.

Factors influencing the multiplier are: risk aversion, uncertainty (volatility) on investment returns, balance sheet quality, asymmetric information on investment returns.

The 0.0x% on reserves probably doesn't matter, but the risk adjusted returns on lending for private investments may be lower than zero.

If capital goods and labor depreciated, returns would go up, but it doesn't seem likely. The PPI have been outpacing the CPI since the deflation scare in 2008. Returns are likely to have further shrinked.

[Lee Kelly]

Why do corporations borrow money? To spend it on investment projects. When do corporations not need to borrow money? When they already have enough money to fund investment projects. When do corporations not spend the money they already have on investment projects? When there is not enough future demand for the final products. When isn't there enough demand for the final products, despite current increased savings? When the present and future level of nominal demand (relative to prices) is too high, i.e. when there is an excess demand for money.

Nobody wants to invest today in products which may hit the market before nominal demands are sufficient. Nobody wants to hold many commercial bonds or stocks for the same reason, so everybody is seeking safety in government debt and, unhappily, money. Nobody wants to borrow from the banks because ... well, you borrow money to spend it; if you already have the money but are not spending it, why borrow more?

Puzzle solved: there is an excess demand for money that is expected to persist for an unknown length of time. The Fed can do something about it but, for whatever reason, isn't.

[Lee Kelly]

Oops, the final line of the first paragraph is supposed to read:

"When the present and future level of nominal demand (relative to prices) is [b]too low[/b], i.e. when there is an excess demand for money."

[Jim]

I like the way Bob Higgs writes.

And I agree with Silvano; banks are still bankrupt. It is the fallacy of TARP; better for the economy to have pounded out all this bad debt in bankruptcy court instead of going through the baton death march we have experienced ever since.

Question: How does the American dollar as global currency affect monetary theory? Wouldn't it tend to minimize any national effect? Off the top of my head, more than half the currency is probably held in other countries. And unlike say, Canada, the Fed is to some extent just exporting (or dispersing) inflation across the planet, much like dispersing an oil spill throughout the Atlantic as opposed to Lake Erie.

[Silvano]

Where it's possible (and in order) to avoid write off, banks will continue to give financial supporp to inefficient firm behaving sometimes like a de facto shareholder.
They are trying to reduce maturity mismacht and continuing to invest in Treasury.
Since Government prevended a liquidation and a recalculation process the demand side is spartially "saturated".

[silvano]

No Kelly. Many Corporations with their malinvestments are still alive. No manager is really interested in the aggregate demand. Their
Point of view is micro not macro. Bailing out failed banks means to make errors persist. No one is going to spend money to buy wrong products. But at the same time these corporations continue to employ scarce factors. And policy makers add uncertainty to uncertainty.

[Lee Kelly]

silvano,

You're right, managers do not care about aggregate demand. They care about the demand for their particular products. My description made it seem like I meant otherwise, but I didn't. Implicit in my comment is that managers do not know the difference between a general fall in demand and a fall in demand for their particular products. They respond to each by cutting back production, because if people aren't demanding their products, then they must be demanding something else instead, right? Wrong. That's the problem: with a general fall in demand there is no increase in demand for anything else. Every manager, on average, cuts back production, lays offs workers, closes business, etc., and those resources are not put to any alternative use, i.e. they are "idle."

It may be that entrepreneurs are struggling to figure out what people want instead of houses and such, but they sure aren't going to begin figuring it out until the aggregate demand deficiency is resolved. And waiting for prices to fall will be a long and painful wait, never mind a disruption to the existing plans of savers and borrowers. No manager can reduce his prices until those he buys inputs from reduce their's, otherwise he'll go out of business before prices adjust. There is a who goes first problem, and nobody will have an incentive to go first.

[FC]

Lee Kelly,

Why do you think that managers (1) do not have cash reserves or other liquid assets and (2) never share price and volume information with suppliers and purchasers?

[Silvano Fait]

@Lee Kelly
Yes. Ok, recovery is painful. Especially when you have experienced a huge bubble in a labor intensive sector like real estate. A sector whose final product affects also the relocation of workforce.
But you can't treat the entrepreneurs almost like a whole class, even if there are several sectorial imbalances and many bankrupts or foreclosures.
After a bust, a cluster of entrepreneurial errors reveal its nature and businessmen realize that many factor are badly employed, many previous investments are simply real losses and they wasted money and real resources.
There aren't idle resources. There are resources in a sub marginal position and that's why they are dismissed. At the same time you have some players that now are in an infra marginal situation and oppose resistance (institutionally, politically, etc.) to be relocated.
Obviously there is also a minority of entrepreneur that is setting up successful firm. But now it's easier to notice trash than diamonds.
Policy makers simply create more uncertainty. Producing for Government it's completely different than producing for consumers. A recalculation process will not start from Washington.

[Jerry O'Driscoll]

Some of the reserve creation has supported lending overseas. And asset bubbles.

Banks are capital-constrained, which works on the supply side of credit. Individuals and companies are still deleveraging, which curtails demand for credit.

For two years, I have heard the same refrain from bankers. They have two types of customers: (1) those flush with cash who do not want to borrow; and (2) those who want to borrow, but who are poor credit risks.

The prime lending rate is not really a market rate. LIBOR is much more market-sensitive. Business loans are priced over LIBOR. That rate is still pretty low. Getting 25bp on reserves is a risk-free alternative to lending.

The near-zero Federal funds rate has torpedoed the interbank market. There is not enough return for the risk of lending to other banks.

[RPLong]

I'm a novice, but there is a part in Human Action in which Mises points out that inflation will fail to occur if people become aware of the inflation game. (Obviously, I'm paraphrasing.)

Banks are sitting on it because they know it's worthless. It doesn't matter anymore that the Fed is running the printing presses 24/7. Banks can't make a profit from the money without eroding their returns to the point where they don't make money anymore. The jig is up. I think everyone is frozen solid because the first one who moves crumbles the whole structure.

At least this way, they can exist forever, doing nothing. We're looking at a monetary Sword of Damocles in my opinion.