Is QE Inflationary?

by Michael J. Howell17. February 2014 09:09
Now that tapering of QE is starting the debate about money and inflation has resurfaced. Where do we stand? Does printing money cause inflation? First define your terms. Do we mean high street inflation, asset price inflation or something else? Second, what do we mean by money? Money has two forms: as means of purchase and as means of settlement. Central Bank QE can change the volume of both, but in the short-term it has most influence over means of purchase that start the economic circuit. QE itself is largely an intermediating process that channels funding to credit providers. QE serves as a direct substitute for other types of funding, such as traditional bank deposits, which is what economists by convention term 'money supply'. However, lately QE has replaced non-deposit funding, such as wholesale funding, e.g. repos and commercial paper, which collapsed post-Lehman. The supply of money is not necessarily affected by this increase in funding, but the volume of credit should be. Therefore, we need to reframe the question? Does an increase in funding cause: (a) an increase in high street inflation and/ or (b) an increase in asset price infation? By lessening the need for forced sales of collateral and reducing rsk premia on asset prices, QE should certainly boost asset prices. Among these a key one is the exchange rate, say, measured in terms of gold. If QE causes the exchange rate to devalue, then it is possible that cost pressures will rise and high street inflation kick-off. However, this surely depends on the flexibility of business, the state of labour and product markets and the degree of spare productive capacity. In short, Central Bank QE represents monetary not cost inflation, since high street prices depend more on costs and asset prices more on money, the vent of QE typically tends to be faster asset price infation. So, does QE cause inflation? Yes, but no! See: The Quality Theory of Money, CBC report 2006. If you believe that 'money' is important the quantity theory works, but if you figure velocity matters too, then you need to think about the quality or liquidity theory of money.

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