Over the last nine months Federal Reserve monetary policy has been working over time with a huge expansion of the money supply, especially in the monetary base, that is setting up the U.S. economy for significant price inflation in the not too distant future.
I discuss the Fed’s activist monetary policy in terms of a various monetary aggregates in a new piece of mine on, “Federal Reserve Monetary Expansion Threatens Future Price Inflation.”
The monetary base grew by 90 percent between August of 2008 and early April 2009. Two other monetary measures, M-1 and M-2, respectively, went up 18 percent and 10 percent during this period.
Why hasn’t the large growth in the monetary base been reflected in higher rates of growth in M-1 and M-2? Because a large proportion is being held by banks as excess reserves, i.e., reserves in excess of required reserves on outstanding depositor liabilities.
In August 2008, excess reserves equaled 4.4 percent of total bank reserves. In early April 2009, according to the latest Fed report, excess reserves stand at 93 percent of total reserves.
Banks have been shoring up their cash position in the wake of the financial crisis that broke out last year. Also, the continuing uncertainties about the economy, and especially government regulatory, fiscal and monetary policy, have made many banks reluctant to get themselves out on a limp again. And, in addition, the Federal Reserve has been paying a positive rate of interest on excess reserves held by the banks.
But when those excess reserves starting being lent out, either to private sector borrowers or to the Federal government to fund its massive budget deficits this year and next, those hundreds of billions of dollars created by the Fed will start putting upward pressure on the prices for investment goods, labor, resources, and consumer goods.
The lingering fears expressed in the media about price deflation will turn into the reality of rising price inflation.