Updated: Aug 22, 2022
Perhaps quantitative easing was inflationary after all
"We've never had a decline in house prices on a nationwide basis. So what I think is more likely is that house prices will slow, maybe stabilize: might slow consumption spending a bit. I don't think it's going to drive the economy too far from its full employment path, though." - Former Fed chairman Ben Bernanke, 2005
"We believe the effect of the troubles in the subprime sector on the broader housing market will be limited and we do not expect significant spillovers from the subprime market to the rest of the economy or to the financial system." - Former Fed chairman Ben Bernanke, 2007
"...we were never concerned about [inflation]; that was just bad economics; inflation was never a risk and is not a risk now…inflation is non-existent and we’re adding 200,000 jobs a month to the economy. Four years later there’s not a sign of inflation. The dollar is strengthening. They’re saying, ‘Wait another five years, it’s going to happen.’ It’s not going to happen.“ - Former Fed chairman Ben Bernanke, 2014
“Slowly we became silent, and silence itself is an enemy to friendship.” - Norman Maclean, A River Runs Through It And Other Stories
Given the catastrophic experience and consequences of Weimar era hyperinflation, many Germans, in the wake of the 2008 deflationary shock - aka the Great Financial Crisis or GFC - were strongly opposed to the use quantitative easing - QE, something they considered to be akin to money printing and thus inflationary. Given where inflation is today, should we have listened to them after all?
In the years that followed the GFC, despite fears to the contrary, ever bulging central bank balance sheets in the US, UK and Japan resulting from QE were not accompanied by high inflation. As a result, even the Germans fell silent, paving the way for the ECB to begin its own QE program in March 2015.
The case for QE as a tool to battle deflation was set out in a 2002 speech by former Fed chairman Ben Bernanke titled Deflation - Making Sure It Doesn't Happen Here. Six years after the paper was written, the US - and much of the world - faced deflation and Bernanke's blueprint became his playbook - he had by then been appointed Fed chairman. From mid-2008 to its peak in November last year, the US monetary base increased 635%. This compares with an increase in consumer prices over the same period of 28%. In other words, it was a huge - unprecedented, even - increase in real terms.
The suggestion that today's high inflation is related to the massive central bank asset purchases that began in 2008 is a contentious one. Indeed, the fact that consumer prices only rose 28% - 2% per annum - during a period in which the monetary base increased 635% is instructive. How on earth can inflation that only recently rose sharply be blamed on central bank asset purchases that began 13 years earlier?
If a reaction to something is not immediate, it does not necessarily mean there is no direct cause and effect. In his 1912 paper On the notion of cause, Bertrand Russell argued against the belief held by many philosophers at the time that there could be no temporal gap between an effect and its cause. "If there are causes and effects,” Russell wrote, “they must be separated by a finite time-interval". The clear temporal gaps between cigarette smoking or greenhouse gas emissions and their effects years - or even decades - later support his conclusion.
Thus, the suggestion that today's high inflation is in some way due to the massive balance sheet expansion that began in 2008 may be a valid one. This is particularly the case given that monetarist economic theory posits a direct link between inflation of the money supply and inflation in goods and services, as indeed warned by many at the time.
Of course, there are other factors behind the rapidly rising inflation over the last year or so such as Covid-19, Ukraine, and Biden's $1.9tr fiscal stimulus. However, that they played major roles does not negate the possibility that the stage had been set years earlier.
In his 2002 speech, Bernanke stated, “If we do fall into deflation, however, we can take comfort that the logic of the printing press example must assert itself, and sufficient injections of money will ultimately always reverse a deflation.” His use of the term printing press is particularly interesting, given that central banks have made every effort to explain that QE is not the same as money printing – aka monetisation, helicopter money, deficit financing, etc. “QE is not the same as printing cash”, states the Bank of Canada website.
Except for the odd financial journal that says, in stark contrast to the Bank of Canada’s website, “QE involves printing money to buy assets”, most explain that the key difference between the two is whether the assets that are bought by central banks as part of their QE activities – government bonds, mortgage backed securities or, in the case of Japan, equities – are permanently removed from the system or not. If the assets are eventually sold back to the secondary market or – in the case of bonds – allowed to mature, this is deemed to be QE not money printing. In other words, QE is QE if it is accompanied by quantitative tightening, the process by which central banks shrink their balance sheets. Otherwise, it's money printing.
Below is a chart of the US monetary base, the Fed’s balance sheet, going back to 1915. It is hard to spot when it has been shrunk on anything other than a temporary basis.
Source: Federal Reserve
As to whether the high inflation today was caused, in part or in full, by central banks' money printing over the last 13 or so years, that is a question I will consider in more detail in a later post.
The views expressed in this communication are those of Peter Elston at the time of writing and are subject to change without notice. They do not constitute investment advice and whilst all reasonable efforts have been used to ensure the accuracy of the information contained in this communication, the reliability, completeness or accuracy of the content cannot be guaranteed. This communication provides information for professional use only and should not be relied upon by retail investors as the sole basis for investment.
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