FED’s QE and Price Inflation

There’ve been two posts about an alleged lack of price inflation accompanying the FED’s massive buying of bonds during QE1, QE2 and QE3. See here and here. Here’s my two cents, which adheres to the Austrian business cycle theory, but with a bit more specificity.

The FED’s buying boosted the prices of long-term assets (stocks, bonds and real estate). That’s where inflation has occurred. The relatively high prices of these assets at this time is a fact. Interest rates are on the low side, and that’s a result of bond prices moving up. Real estate prices have completely recovered from their 2008-2009 crash. So have stock prices, and stocks are definitely richly priced by well-known measures, including dividend yields, prices relative to GDP, and Shiller-type measures.

With higher stock prices and economic recovery, production has increased. With more consumer goods being made, their price increases became somewhat restrained, although not absent. Service prices rose more greatly, and so have wages.

Much of the FED’s buying was directly of housing bonds issued by federal housing agencies. The agencies were able to finance housing. The money transferred into the housing industry has found its way into other markets, including both consumer goods and long-term assets. Where it goes is unpredictable. As long-term bonds rose in price with the QE programs, short-term bonds appeared more attractive. As their prices rose and their yields fell to near zero, stocks became more attractive and so did real estate. These were bid up in price as the money flowed to them. The FED’s buying program was concentrated in long-term bonds, but the impact spreads by substitution to all asset prices.

The prices of consumer goods would have risen as in some past inflations if the FED were buying government bonds while the government was financing a war, for then the government’s use of the new money would be competing with the private economy for material, labor and goods, as well as defense products. But in this inflation, the path of the money was more toward the housing sector.

Another factor of importance is that much of the new money is being held as bank reserves. Overall credit growth was slow to recover, but has now moved up into a more usual recovery range. Without credit being advanced, bank-created money growth has been restrained. That can change. It’ll probably move up further, cause more inflation that we’ll see in consumer goods, and then the stage will be set for another recession. That’s 1-2 years off. Trump clearly wants it to be deferred until after November 2020, which is why he continually browbeats the FED and Powell to lower interest rates. He wants to juice the economy and defer the onset of the next recession.

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6:59 pm on July 11, 2019