December 12, 2014

INFLATION ISN'T A FUNCTION OF DEMAND EITHER...:

4 things I got wrong about the Great Recession (Mark Thoma, 12/11/14, The Fiscal Times)

[H]ere are some of the things I got wrong about the Great Recession:

It's hard to change the inflation rate in a deep recession: Prior to the Great Recession, I thought central banks could create inflation pretty much at will, even in a deep recession. All that was needed was to crank up the printing press, get the money into the hands of people who will spend it, and the extra demand will drive up the prices of goods and services. At the same time, inflationary expectations would increase driving down the real interest rate, and that would increase demand even more. If the increase in the money supply is sufficiently large, inflation would be the inevitable result.

But the Fed doesn't create money directly, it increases bank reserves and it's possible for those reserves to get stuck in bank vaults or in deposits held at the Fed. When that happens, the money supply doesn't increase -- balances held within the Federal Reserve System are not part of the money supply -- and the desired increase in demand doesn't occur.

The lesson for me is that if you want the inflation rate to increase, demand has to increase. That requires more than simply creating a bunch of reserves that sit idle in banks.

..so long as labor costs are declining. 
Posted by at December 12, 2014 3:33 PM
  

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