Why has inflation been so low in the past few years?
If interest rates are near zero, and they have been for some years, doesn’t that mean that corporations can borrow pretty much all the money they want? Since the lenders only keep a small “reserve” of what they lend, wouldn’t all this borrowing result in a big increase in the total supply of money?
If we have more or less the same things to buy, and there’s a lot more money floating around, wouldn’t that mean high inflation?
The Money Supply Is Increasing
The Federal Reserve publishes their estimate of the total amount of money in the U.S. They call it “M2” and it includes everything, bank accounts as well as currency. In July of 2011 it was $9,232.6 trillion, or $9,232,600,000,000. At the end of June 2013, it was $10598.4 trillion. That’s an increase of $1,365.8 trillion in 2 years. I didn’t pick the years, they were just the first ones I found. Probably, the money supply increased a lot more in the 2007-2009 recession period, so the change would be even more dramatic than this recent 15% increase.
That’s Monetary Policy
The operations of the federal reserve are usually made to sound pretty dark and unfathomable, but essentially all they do is increase the money supply in hard times. They have a number of ways to do it, but it’s still just about all they do. I don’t think they can even constrict the money supply — they can just make it grow faster or slower.
Fiscal policy is actually a lot more important. That’s government spending. If the people running the American government had really wanted to get out of the 2006 recession quickly, they would have turned on the spigots of government spending. They didn’t because they didn’t want to. That left the entire problem up to the Federal Reserve and the expansion of the money supply. They fell to their task mightily.
They lowered interest rates to near zero so that businesses could basically get all the money they might want. They started “buying” treasury bonds with money they basically manufactured. Trillions of dollars went into the economy and the goods and services didn’t actually change that much. If something was worth $10 when there were $5 trillion in the economy, it makes sense that its price would inflate to $20 when the money supply doubled. But it didn’t.
So, why no inflation?
Money Has to Move
The velocity of money is how fast it moves through the economy. If it doesn’t move through the economy, it has practically no effect on prices. If the government gives trillions of dollars to fat cats who just sit on it, store it in overseas accounts, or just use it to buy back their own stock, which is what they did, prices don’t change much.
If the government had fought the recession with fiscal policy, inflation would likely have been more of a problem. If the government had hired some of the many unemployed to fix some of the infrastructure, teach the children, or prepare for the future, the new money would have gone into wages — and those wages would have been quickly spent. More money and more velocity at the same time would have resolved the recession more quickly, but there would have been more inflation.
So, the short answer to “why no inflation?” is that the new trillions of dollars went to very wealthy people who just kept it.
Why is Economics so Dark and Illogical?
In olden days, a “philosopher” was someone who generalized from a great deal of knowledge. Today, we divide up all knowledge into various “disciplines” with geniuses in one field completely ignorant of any other field. We divided politics from economics for Heaven knows what reason, and neither one of them makes any sense without the other. The Polysci grads don’t know beans about economics and the Econ grads don’t know politics.
The Polysci profs snow everybody with statistics because they don’t really want anybody to know their arcane secrets. The Econ profs do the same thing. My friend Jorge Rieger compared them to the secretive priests of old, and it’s a pretty good comparison. If you’re interested in a simpler explanation of economics, click here for the Little School.