Why doesn’t QE cause inflation?



When central banks buy bonds and mortgage-backed securities, doesn’t that add more cash to the financial system? If no inflation results, could they simply buy all the debt? IIRC Germany couldn’t find enough buyers for their 30 year negative yield bonds, so their central bank ended up buying most of them. If that’s possible, why wouldn’t a country want to run up the deficit and fund it via QE?

In: Economics

Because you can’t effectively tell whether adding money to the money supply will cause inflation or not. So you add money cautiously, and then keep an eye on the data to make sure inflation stays under control after the fact. If it doesn’t, you scale back your addition to the money supply.

That’s in normal times. In times like these where everyone’s shitting their pants, you just pump money into the system. It’s akin to giving adrenaline to a person who’s had a heart attack – you go for something drastic and deal with the consequences later

So what is inflation? Simply put inflation is the increase in prices which occurs as the result of the increase of the supply of money. So an increase in the supply of money alone is not enough to trigger inflation. Inflation occurs when that increase then triggers a chain reaction which results in an increase in the prices of goods.

So to understand why QE doesn’t always increase prices you have to understand the processes that trigger price increase. When the price of most things is in fact fixed then it doesn’t matter how much money you print. And this is why QE is so dangerous: it allows the few who get the newly injected supply of money to buy anything they want with it, in the context of fixed prices.

Now we get to the key point: QE increases prices in the situations in which a bidding context occurs. So what’s a bidding context? Let’s assume you and I just got off from seeing daddy central bank and he was so generous in giving us some newly printed dollars to play with. Now suppose we both walk into a car dealership to buy ourselves some nice cars. In this case it doesn’t matter how much money we’ve got, the only thing that matters is if we’ve got enough money to cover the price of the cars we want to buy.

So here the money we have does not influence price, because we’re dealing with fixed prices.

But say now both of us want to buy a house. And the asking price is 1 million USD, let’s assume that daddy central bank gave me 800K of the newly printed dollars, and he gave you 900K. At which price do you think the house will sell? Most probably at 900K if you really want the house. Now suppose I really do want the house and I go back to daddy central bank and convince him to give me an extra 300K because I so want that house really badly. Then now I have 1.1 million USD and I could buy the house straight up for the asking price of 1 million USD and have me a nice 100K left to play with.

Now assume that you really are determined to get the house and go back to daddy central bank and guilt him into giving you an extra 400K because after all you’re his favorite kid. In that case you would come back to the realtor and say you’ll take the house for 1.3 million USD right there and then. Then essentially now the house price went from something like 800K-ish to 1.3 million USD.

Essentially what’s happening here is that we’re locked in a bidding contest, and in this case the more money we have – the more money is printed to allow us to play our silly games- the more the prices will increase because we’re constantly trying to outbid each other.

QE’s is most dangerous not because it creates inflation, but because in the context of fixed prices it allows somebody to get something for nothing. Don’t let the term fool you QE means we’ll give a few people a bunch of made up money so they can buy stuff with. Generally they’ll give money to banks and banks will loan the money to citizens. Then citizens will pay interest on those loans, and that’s where reality is injected back into that made up money. Essentially **QE preys on the average man and woman because it forces them to pay interest on something that’s completely made up.** It’s a complex and really intricate system, but that’s what it really comes down to.

Every single time you hear them doing another round of QE, understand that they’re giving somebody permission to get something for virtually nothing or they’re giving nothing to hardworking people to later force them to pay interest on it.

Remember quantitative easing is simply increasing the money supply, and when the money supply increases without a concomitant increase in value created then that is a clear sign that the economy is running on lies and make believe.

That’s my two cents. Hope it helps!

Scanning through this, no one has provided the actual answer: It’s called **interest on excess reserves** and it is the only reason QE didn’t cause hyperinflation. The reason QE would tend to cause massive inflation is because of the money multiplier effect. QE creates new base money. As you are probably aware, depository institutions such as banks then multiply this base money by accepting deposits and making loans. Adding to the monetary base can quickly expand the money supply and lead to inflation. So while the Fed created a bunch of new base money, it also started paying interest on excess reserves to prevent that inflation.

The Fed has always required banks to keep a portion of their money deposited with it, based on how many deposits they have. In short, every time you deposit a dollar with a bank, a portion of that dollar has to be kept in an account with the Fed. The Fed has always paid interest to banks for the amount they were **required** to deposit with it. After the 2008 crisis, the Fed also began paying interest to **all** deposits banks make with it, not just the required ones. This kept the banks from lending all that new money out, creating new deposits, and expanding the money supply. The result was [this](https://fred.stlouisfed.org/series/EXCSRESNS). Over the past 10 years, banks have kept between $1 and $2.7 trillion deposited with the Fed above and beyond the regulatory requirement…because it’s paying them to keep it there.

This is base money that is just being held out of the economy and you are paying to keep it that way.

This indeed stabilized the banking system, but it also made the Fed’s job much more complex until it can drain away all those excess reserves. Another round of QE is going to be unfortunate, since as you can see from the graph, we had been steadily reducing those reserves since late-2014.